Market Close: Muni's Reaction To Treasury Rally Will Be Muted, Traders Say

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Tuesday's Treasury sell-off will have a minimal impact on municipal bonds this week, investors said.

Market participants said the low supply expected during the four day holiday week will keep yields on municipal bonds low, and that Treasuries would have to continue selling off dramatically to have a moderate impact on munis. Supply this week is scheduled to come in at $2.27 billion, according to data provided by The Bond Buyer and Ipreo.

The 30-year Treasury's yield jumped by 11 basis points to 3.17%, the 10-year increased nine basis points to 2.42%, and the two-year note ticked up five basis points to 5.3%.

Yields on municipal bonds held steady at 0.30% for the two-year, increased by one basis point to 2.08% for the 10-year, and rose by two basis points to 3.23% for the 30-year, according to Municipal Market Advisors' data.

"[The municipal market] does not seem like it will be impacted much [by the Treasury sell-off]," a trader in New York said. "Treasuries fell pretty hard because of the manufacturing numbers. I think looking at a lot of factors, in terms of supply in the tax-exempt market, along with relative basis lots of value in buying tax exempts versus Treasuries, those two factors have more of an impact on muni market than absolute movement of Treasuries."

Treasuries began selling-off right after the ISM Manufacturing Index's released a positive report that showed the ISM manufacturing composite index rose 1.8 points to 57.1 in July. This is the best reading the index has shown since April 2011.

"I don't think [Treasury's effect on munis] is going to be dramatic because it's a low week in supply," a second trader from New York said. "It's a pretty big [Treasury] sell-off, but I don't think munis will be in lockstep with Treasuries this week."

A trader in Florida said that Treasuries may have sold off so radically because no extremely negative headlines about the situations in the Ukraine, Iraq or Israel came out over the weekend.

"With those headlines limited, there is no reason for people to buy Treasuries until the next negative headline hits," he said.

The trader on the West Coast predicted that municipal bond yields will continue to stay low for an extended period of time.

Yields on municipal bonds rose the most for seven-year maturities increasing by four basis points, according to Municipal Market Data. Muni yields increased three for bonds maturing in eight to 13 years, by two basis points for bonds maturing in 14 to 30 years, by two basis points for four to six year maturities, and by one basis point for bonds maturing in two to three years.

INVESTORS BUY LOWER COUPONS

Investors said they have seen market participants buy lower coupon bonds in an attempt to pick up some yield in the current low yield environment in the secondary market.

The two most actively traded bonds listed on EMMA- the Indiana Finance Authority's 4s of 2044 refunding revenue bonds issued for the southern Indiana gas and electric company projects and the New York City 3.5s of 2033 general obligation bonds- appealed to investors because their low coupons meant investors could probably purchase them for less than 5% coupon bonds from the same issuer, according to investors.

"A lot of times people buy lower coupon bonds if they see some value to them, if there is a big spread between the 5% and the 3.5% coupon bonds and at some points and times investors would be able to buy the bonds at a discount," the first trader in New York said. "If the spread differential is wide enough traders might look to buy because feel a little bit value. The market has run up dramatically and as a result of that investors are now hard pressed to find good value."

The Indiana Finance Authority 4s of 2044 yielded 3.99%, and the New York GOs ranged from a low of 3.30% to a high of 3.55%, according to data provided by EMMA.

In contrast, the Indiana Finance Authority 5s of 2037 traded at 3.37% on Tuesday, according to data provided by Bloomberg. The New York City 5s in 33 GOs traded at 1.95%.

"It's possible if [investors] think yields are going to stay low for an extended period of time, it would be the case [that they would look to lower coupon bonds]," a trader on the west coast said. "We're seeing a lot of people do that now."

Yields on the benchmark 10-year triple-A GO have fallen by 72 basis points to 2.07% on Friday from January 2, according to Municipal Market Data. The 30-year's yields have dropped by 117 basis points to 3.03% during the same period.

The West Coast trader did say the value of the low coupon bond depends on the call date, and that if bonds have longer call dates they might actually come richer than 5% coupons.

"If you have a shorter call that is not the case, because there is a higher likelihood the bond is going to be called," he said, and said bonds with call dates out 20 years or more tend to come as rich or even more expensive as 5% coupon bonds.

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