COVID-19 sends muni and UST yields to uncharted territory
As fear and uncertainty over COVID-19 increase by the minute, it has sent yields for both municipals and Treasuries never before seen low levels — begging the question if we could see zero or negative yields here in the States.
This past week was a firestorm of complex events, with the end result being utter shock of how low we have come in terms of yields so quickly.
“I haven’t seen anything like what we have seen this week, or even today,” said Jim Colby, senior municipal strategist and portfolio manager at VanEck on Friday morning. “It is absolutely possible we can get to zero, or dare I say even negative yields here — it is just hard to tell when exactly.”
If Friday's pace continues, that might not take long. The 10-year Treasury on Friday opened at 0.920% and it quickly dropped down to an all-time low of 0.660% before 11 a.m. ET.
One year ago, the 10-year UST yielded 2.690%.
“I never thought I would see the 10-year UST below 1%,” Colby said. “Lots of other places around the world have negative-yielding debt and this virus situation is the catalyst that could send us there as well.”
Brian Musielak, senior portfolio manager for Commerce Trust Co., said that they have felt that under the new normal conditions of lower growth, lower inflation, and ultimately lower yields, 0% USTs yields were a possibility, especially during a recession.
"The reaction to COVID-19 has certainly changed the market’s outlook for decisively negative growth prospects this year," he said.
The emergency Fed 50 basis point rate cut on Tuesday was intended to help with COVID-19 fears, but some participants said it seems to have made things worse.
“We now expect another 50 point cut or some sort of stimulus package from the Fed to help turn things around,” Colby said. “One thing that does stand out and has not changed, is that from a value proposition, munis are looking very attractive.
“Everything amounts to a slowing of the economy and now that is being reflected on the rate markets,” Colby said.
BofA Global Research said fallout from the COVID-19 is forcing a reassessment of Federal Reserve actions, which will affect muni volume for the year.
BofA economists and rates strategists said they now expect the Fed to cut 25 basis points on March 18 and another 25 basis points on April 29. The Fed Funds futures market implies even more cuts, so BofA expects an aggressive Fed easing posture going forward.
“Front-end muni rates and ratios look too high given the aggressive Fed posture,” BofA said in a market report. “Low rates and high muni/Treasury ratios suggest more taxable advance refunding bond issuance than we previously estimated; we raise the taxable bond issuance volume for 2020 to $125 billion and total issuance volume for the year to $450 billion.
Looking at performance, BofA expects more steepening in the one- to 10-year part of the muni AAA curve until short-end ratios stabilize. The report said that the 10- to 30-year AAA steepening was mild and should be temporary, and that flattening should resume once macro market volatility stabilizes.
“High muni/Treasury ratios in the 10- to 30-year area present good opportunities for investors who want to stay in fixed income,” BofA said. “Muni spread compression process remains intact, with the ICE BofA BBB-rated and high yield indexes' OAS delivering new record lows.”
Sticker shock is causing some retail investors to either sell their municipal bonds — or sit on the sidelines — while municipals follow Treasuries lower, according to a New York trader.
“The 10-basis point jump in the MMD forced them to put their pencil down,” the trader said.
With outflows for the first time in 60 weeks, investors are remaining on the sidelines until rates back up, the trader said.
“I haven’t seen a Treasury market like this in a long time,” he said, referring to the 10-year benchmark yield at sub-0.70% yields at times Friday.
Friday’s market was expected to end eight to 10 basis points lower in yield after MMD cut yields between 2021 and 2050.
“When you get these low fractionals that doesn’t work for [investors],” he said.
“When the rates get so low retail gets sticker shock and it’s very alarming for them.”
Meanwhile, the more sophisticated investors are opting to sell their municipal bonds — rather than sell their stocks.
Munis were stronger on Friday on the MBIS benchmark scale, with yields falling six basis points in the 10-year and by two basis points in the 30-year maturity. High-grades were also stronger, with yields on MBIS' AAA scale decreasing by five basis points in the 10-year maturity and by four basis points in the 30-year maturity.
Munis strengthened on Refinitiv Municipal Market Data’s AAA benchmark scale, as the yield on the 10-year muni GO was 10 basis points lower to 0.86% and the 30-year fell 10 basis points to 1.46%.
Both yields are historic for the benchmark, as the old record low for the 10-year was 0.93% on Feb. 28 and the 30-year was 1.52% on Feb. 27. “Coming into 2020, the MMD 10-year all-time low was 1.21% and the 30-year all-time low was 1.83%,” said Greg Saulnier, TM3/MMD senior managing analyst. “The 10-year spot has made eight new record lows this year, with today marking the ninth occurrence. Likewise, the 30-year has made seven new lows, with today being the eighth.”
"Munis are historically slow to follow sizable moves in Treasury yields," Musielak said. "So it is not surprising munis have been slow to react this past week. If Treasury yields remain this low, munis yields will likely go even lower."
The 10-year muni-to-Treasury ratio was calculated at 119.4% while the 30-year muni-to-Treasury ratio stood at 122.9%, according to MMD.
Stocks were sinking further again and all major indexes were down by at least 3% on renewed fears of COVID-19, while Treasuries rallied and yields were sharply south and have entered uncharted territory.
The Dow Jones Industrial Average was down about 3.00%, the S&P 500 index was lower by 3.70% and the Nasdaq lost roughly 3.80% late in the session Friday.
“Equity markets are reacting violently to concern over the virus threat,” Colby said.
The three-month Treasury was yielding 0.456% earlier before moving back up to 0.494%, the Treasury two-year was yielding 0.477%, the lowest since Jan. 2015, the five-year was yielding 0.554%, the 10-year paved a new low yet again at 0.660% before ticking back up to 0.699% and the 30-year was yielding 1.200%.
Block trading of various high-grades showed yields moving benchmarks lower. Georgia GOs, 5s of 2021, traded at 0.53%-0.50%. Back on Feb. 25, it traded at 0.82%-0.77%. Fairfax County, VA 5s of 2024 traded at 0.59% Friday and 0.63% Thursday. Ohio Water Development Authority 5s of 2028 traded at 0.87%-0.86%. On Monday, it traded at 1.02%-0.95%. Forsyth County, NC GOs, 5s of 2030, traded at 1.04%-0.97% Thursday. Washington GOs, 5s of 2033, traded at 1.22%-1.21%. Delaware GOs, 2s of 2036 traded at 1.69%. When it priced on Jan. 22, it yielded 2.19%. Iowa Finance Authority green bonds, 5s of 2044, traded at 1.55%-1.47%, originally priced at 1.89% on Feb. 20.
Volume is estimated at $11.01 billion, with $9.45 billion of negotiated deals and $1.56 billion of competitive sales. There is a total of 31 deals scheduled $100 million or larger, with five of them competitive. Eight of the $100 million or larger deals are taxable or have a taxable tranche.
"We think the deals next week will all be priced to sell and the lower quality issues may really struggle," Musielak said. "Dealers will not want to be left with any sizable balances given the challenges of hedging their exposure in such a volatile market."
He added that low absolute yields and high ratios are the perfect environment for taxable refunding issuance to remain strong.
"We do expect to see more new money taxable issues," he said. "Besides the low yields, issuers have much more flexibility with structuring taxable deals."
Citi is scheduled to price California’s (Aa2/AA-/AA/NR) $2.17 billion of various purpose general obligation and refunding bonds on Tuesday.
BB&T Capital Markets is slated to price New Hope Cultural Education Facilities Finance Corp., Texas’ (NR/NR/NR/ ) $668.95 million of senior living revenue tax-exempt and taxable bonds. There is no specific date for pricing, as it simply says week of March 9. It was supposed to price last week.
There is another deal that is scheduled for the week of March 9, with no exact pricing date and that is Goldman Sachs pricing of John Hopkins University’s (Aa2/AA/AA+/NR) $470 million if taxable corporate CUSIP bonds.
JP Morgan is expected to price Ohio Water Development Authority’s (Aaa/AAA/NR/NR) $450 million of water pollution control loan fund revenue bonds on Wednesday.
“Purely from an opportunity standpoint, there is a nice mix of deals,” Colby said. “In the high-yield sector, the marketplace is really starved for some more variety and opportunity in different sectors.”
Colby added that it remains to be seen if the pendulum switched in terms of flows.
“It was an incredible stretch, I suspect if the market was giving concern of outflows, the pricing may not end up being as aggressive as they were a week ago,” he said. “After a week like we just had, I don’t know what the appetite is going to be like.”
Lipper reports first outflow in 60 weeks
For the first time in 60 weeks, investors pulled cash from the municipal market and ending the streak four weeks shy of tying the record for consecutive weeks of inflows.
In the week ended March 4, weekly reporting tax-exempt mutual funds suffered $249.657 million of outflows, after inflows of $2.266 billion in the previous week, according to data released by Refinitiv Lipper late on Thursday.
"All roads lead back to concern over the virus at this point," Musielak said. "While low absolutely yields could be a factor, we sense its more of a pure risk-off trade; the likes we have not seen since the financial crisis 2008-09."
Musielak said that he recalls during that time, the fear trade involved selling everything, including high-quality munis and either going to cash or buying Treasuries.
"This past week felt more like a pure risk-off trade as Treasuries decouple from all other fixed-income instruments," he said. "We do not foresee a complete reversal in flows at this point, however likely to experience some more choppiness week-to-week going forward."
Exchange-traded muni funds reported outflows of $156.744 million, after inflows of $522.955 million in the previous week. Ex-ETFs, muni funds saw outflows of $92.913 million after inflows of $1.743 billion in the prior week.
The four-week moving average remained positive at $1.478 billion, after being in the green at $1.948 billion in the previous week.
Long-term muni bond funds had outflows of $377.862 million in the latest week after inflows of $1.674 billion in the previous week. Intermediate-term funds had outflows of $6.813 million after inflows of $359.445 million in the prior week.
National funds had outflows of $204.484 million after inflows of $2.040 billion while high-yield muni funds reported outflows of $128.523 million in the latest week, after inflows of $592.060 million the previous week.
“Some of the muni bond product is linked to revenue-generating enterprises, such as airports, convention centers, hospitals, etc. and certainly there is going to be an impact and the knee jerk reaction would be: I have exposure to some of these places and they are going to feel an economic impact as a result of this virus and to what extent?” Colby said.
Chip Barnett and Christine Albano contributed to this report.
Data appearing in this article from Municipal Bond Information Services, including the MBIS municipal bond index, is available on The Bond Buyer Data Workstation.