Muni buyers took a premature hedge against rising interest rates in Wednesday morning's primary market and were rewarded for their caution.
Traders bid aggressively on the Kansas Department of Transportation deal, which featured adjustable interest rates, allowing buyers to protect themselves against rising interest rates coming from the Federal Reserve, said an East coast based trader.
Their bets paid off when Federal Open Market Committee minutes were released later in the afternoon, indicating that an improved labor market and successful inflation targets would allow them to "begin removing monetary policy accommodation sooner than they currently expected."
In other words, interest rates may be rising sooner than the Fed previously anticipated.
While pricing of Kansas's Transportation deal came before the release of the FOMC minutes, buyers certainly benefitted from the announcement having appropriately hedged themselves against the news, said the trader.
The adjustable interest rate bonds were priced based off LIBOR, ranging from 67% of the One-Month LIBOR Rate minus 1 basis point in 2015 to 67% of the One-Month LIBOR Rate plus 40 basis points in 2019, according to a pricing wire provided by Bloomberg.
"People are trying to hedge out a little interest rate movement and floaters are a decent way to accomplish that," said the East coast trader. "It's a fairly popular structure for the right buyer in the institutional world."
With effectively zero duration, floating rate bonds, like the Kansas deal, are a way for institutional buyers to pick up some interest with sacrificing any duration on their portfolio, added the trader. Kansas's deal was aptly structured, front end loaded and with adjustable rates, to lure in the institutional buyer concerned with rising interest rates, said the trader.
MUNI MARKET SHRUGS OFF FOMC
While the FOMC minutes may have strengthened the front loaded Kansas Department of Transportation deal, short dated Treasury's took a hit. Treasury yields weakened on Thursday, especially on the two-year note, which rose five basis point to 0.48%, the highest yield since August 8. The 10-year rose three basis points to 2.43% while the 30-year stayed flat at 3.22%.
Shorter dated Treasury paper is the most vulnerable to interest rate increases, explaining the two-year note's weakness.
The municipal market, however, closed mixed on Wednesday. Bonds maturing in 2015 and 2018 remained unchanged while those maturing between 2016 and 2017 tightened two basis points, according to Municipal Market Data's triple-A 5% scale. Bonds maturing in 2019 strengthened one basis point, while those maturing in 2020 weakened one basis point. Bond in the long end, maturing from 2021 through 2044, rose two basis points.
According to Municipal Market Advisors' triple-A 5% scale, the market weakened. The two-year note was unchanged at 0.30%, while the 10- and 30-year softened two and three basis points, respectively, to 2.14% and 3.31%.
Because supply has been so limited in the municipal market, the asset class will probably be shielded from impact surrounding the FOMC minutes, said a New York-based trader. The technicals of municipals have been so strong this summer, favoring the seller, that economic data has bounced off the market leaving minimal bruising, as seen with the announcement of the unexpectedly positive 2nd quarter gross domestic product number release earlier this summer, as previously reported by The Bond Buyer.
A TOP IN PUERTO RICO?
Meanwhile in the secondary market, activity was muted. Bids for Puerto Rican debt began to taper off on Wednesday as hedge funds who own the debt contemplated whether a "top" was near.
Prices for the island's public power authority, PREPA, backed off to 50 cents on the dollar in odd lot trading on the authority's 7s of 2043 Wednesday morning, according to Municipal Securities Rulemaking Board's disclosure website, EMMA. The public authority's debt priced as high as 54.25 on the dollar during trading yesterday, still catching strong bids stemming from the positive letter of credit extension announcement.
That confidence seemed to wane on Wednesday, though, as bids for the paper are becoming less frequent, said a New York based trader.
"Hedge funds are hearing that this might be getting to be the time to get out," the trader said. "Last week was good news, but those prices are a little lofty."
PREPA activity has been dominated by hedge funds and other crossover buyers purchasing odd lots from retail investors to increase their positions in the public corporation as it nears a historic restructuring. The debt has rebounded since the buy-side's entry point when the paper plummeted to the mid-30 cent range on the dollar earlier this year.
Those buy-side players may be delaying further purchases as they determine whether this point may be the maximum return on investment, the New York trader said.
Trading volume on the commonwealth’s general obligation bonds stalled as well. During trading on Wednesday just $12.39 million of the 8s in 2035 exchanged hands after $61.8 million was traded on Tuesday, and 47.98 million traded on Monday, according to EMMA.
Yields on the closely followed 8s in 2035 weakened slightly on Wednesday, rising to 8.9% after a low of 8.82% on Tuesday. Yields on Tuesday were the lowest the commonwealth's GOs have seen since Aug. 23, when yields were as low as 8.73%.
Traders agreed that any strength seen in trading on the commonwealth's GO has been piggybacked off of PREPA's announcement late last week.
