Long-term municipal bonds weakened on Wednesday due to renewed jitters about the scarcity of buyers for long-duration tax-exempt bonds.
The triple-A 30-year municipal weakened four basis points Wednesday to 4.83%, according to Municipal Market Data, after weakening a basis point Tuesday. The triple-A 10-year yield was unchanged at 3.34% Wednesday and has tightened 20 basis points since mid-January.
State and local government debt rallied in the second half of January, settling down after a monstrous sell-off that began in November and continued through the beginning of 2011. However, the calm that has descended over the municipal bond market may last only as long as the current supply drought. The present tranquility comes during favorable conditions that include the lightest monthly supply in 10 years.
Many traders, bankers, and investors worry about the fragile market’s ability to absorb a substantial supply of new bonds if and when a flood of issuance comes. That concern may be behind the minor snap-back in long-term yields that’s occurred this week.
“We’ve just gone through the lowest supply of the century,” a Los Angeles trader said, referring to the $12.2 billion of debt municipalities sold in January, the skimpiest monthly supply since 2000. “There’s certainly a little bit of concern about that. ... If we get any spikes in supply it could become more difficult.”
Municipalities sold little debt in January for two reasons. First, because the rush to sell taxable bonds under the federally subsidized Build America Bonds program last year pulled issuance forward. And second, because the 100-basis-point spike in yields that took place in the fourth quarter discouraged issuers who were considering coming to market.
George Friedlander, head of municipal strategy at Citi, called January issuance “extremely sparse” in a research note earlier this week.
Weekly supply in the first four weeks of January was $938.4 million, $4.44 billion, $3.14 billion, and $3.3 billion. That’s well short of the $8 billion weekly average in 2010.
The soft calendar shows no signs of firming up in the aftermath of the Dec. 31 expiration of the BAB program. The 30-day visible supply, which measures the stock of muni bonds slated for sale in the next 30 days, is $9.4 billion. Municipalities came into this week scheduled to sell $3 billion.
The late-January rally notwithstanding, it remains unclear whether the market is capable of digesting a larger serving of issuance.
The concern as Friedlander sees it is the latest stabilization was driven in large part by nontraditional crossover buyers such as hedge funds and life insurance companies, which were tempted into the market by high muni yields relative to Treasury yield.
These buyers have been able to soak up the scant tax-exempt supply that came to market the past few weeks, but their appetite for tax-free debt only goes so far.
Should tax-exempt supply outstrip the nontraditional municipal investor’s capacity to buy it, yields may have to drift up to bring traditional retail investors back into the market.
“The improvement has happened during a period of extremely light new-issue supply,” Friedlander said. “In the absence of substantially improved bond fund flows, it remains unlikely, in our view, that the support from crossover buyers, a handful of traditional institutional buyers such as property and casualty insurance companies, and the limited proportion of direct retail buyers that are willing to look at long maturities, would be sufficient to absorb a more normal-sized new issue calendar without repricing the market toward higher yields.”
This expected repricing was firmly behind Wednesday’s happenings on the long end, according to Thomson Reuters analyst Randy Smolik’s daily commentary. As crossover buyers drift back to the taxable bond sector because of higher yields there, dealers in tax-exempt bonds are trying to unload their long-term muni positions.
The hand-wringing among long-term buyers is rooted in the conversion of mutual funds from buyers to sellers of long-term tax-exempt bonds, which began three months ago. Municipal bond mutual funds have reported more than $31 billion of redemptions since mid-November, according to Lipper FMI.
Fund managers seeking to raise cash to meet these redemptions have exerted substantial selling pressure on the muni market. A Bloomberg index measuring bids-wanted submitted by institutions reached a record $1.4 billion last year.
Some traders said the bids-wanted submitted by mutual funds have subsided this week, indicating that either the outflows have slowed or the funds have already sold enough bonds to meet the anticipated redemptions.
Still, as long as mutual funds continue losing cash, the strongest source of demand for long-term tax-free debt the past two years will still be mostly absent from the primary market.
“If there are no inflows for the market, I’m not sure you have the buyers to absorb a significant change in supply,” the Los Angeles trader said. “We may have to have an adjustment in yields, and I don’t think anyone wants to go through that again.”
Most of the analysts who forecast municipal bond issuance expect a significant drop in bond sales this year from the $433 billion sold in 2010. Citi is predicting $340 billion in issuance, Loop Capital is forecasting $375 billion, and JPMorgan is forecasting $325 billion (the JPMorgan estimate is only for tax-exempt bonds).
On Wednesday, the New York City Transitional Finance Authority priced its $775 million deal in the negotiated market. The bonds, which mature from 2013 to 2035, will carry yields from 0.87% to 5.2% and are rated triple-A by Standard & Poor’s and Fitch Ratings, and Aa1 by Moody’s Investors Service.The longest maturity of the deal priced 46 basis points over the triple-A MMD scale. Goldman, Sachs & Co. was lead underwriter.
In the competitive market, North Carolina sold $500 million of capital-improvement limited obligation bonds, rated AA-plus by Standard & Poor’s and Fitch and Aa1 by Moody’s. Maturing from 2012 to 2031, the winning bids came in from Wells Fargo.
Though the longest maturity was not re-offered, the bid for the second-longest maturity — in 2030 — was 4.83%, or 26 basis points above the triple-A scale.