NEW YORK – As Thursday quieted, traders looked to the New Year for direction in the tax-exempt market.
Traders agree that activity should pick up by mid-January. “As long as [Treasuries] stay where they are and we don’t get huge supply coming in, all indicators point to positive moving forward over the next month to six weeks,” a trader in Los Angeles said. “You’ve got January redemptions and as long as there are no surprises, we’ll be in good shape.”
A trader in Chicago agreed, saying the first week of January could be slow until activity picks up later in the month. “Most people have anticipation for the first week of January and in the last few years, it never seems to meet expectations. Last year, it was slow and people didn’t come in looking to immediately put money to work.”
This trader said people will take a “wait and see” approach, as there is little motivation to get involved in the market in the ultra low yield environment. “The expectation for this year was that eventually rates would start rising and they haven’t,” he said. “So when is that?”
By Thursday afternoon, it was “definitely slower,” the L.A. trader said. “It is clearly winding down. Maybe there were too many holiday parties this week.” He added there was “some activity early, but it has pretty much gotten quiet over the past hour.”
“If it’s going to be exciting, it’s not going to be in the bond market today,” he said.
“Everything is half-staffed or less,” the Chicago trader said. “But customers may need to do something before year-end so somebody has to be here.”
He added there are some bid lists that are interesting but the motivation is not there.
Munis were steady to slightly firmer, according to the Municipal Market Data scale.
On Thursday, the two-year yield closed flat at 0.36% for its 12th consecutive trading session. The 10-year muni yield fell two basis points to 1.91%, a new record low as recorded by MMD, beating the previous record of 1.92% set Monday. The 30-year muni yield fell two basis points to 3.62%.
The Securities Industry and Financial Markets Association recommended an early close of 2 p.m., Eastern time, for bond trading on Friday and a full close on Dec. 26.
The secondary market upstaged the primary market Thursday. Trades reported by the Municipal Securities Rulemaking Board showed firming.
A dealer sold to a customer New Jersey Transportation Trust Fund Authority 5.754s of 2028 at 4.96%, 13 basis points lower than where they traded Tuesday.
A dealer bought from a customer Massachusetts School Building Authority 5s of 2041 at 4.00%, four basis points lower than where they traded Tuesday.
A dealer sold to a customer New York City Municipal Water Finance Authority 5s of 2034 at 3.90%, three basis points lower than where they traded Tuesday.
A dealer bought from a customer Washington 5s of 2041 at 4.01%, three basis points lower than where they traded Wednesday.
Munis have been able to hold mostly steady despite a big sell-off in Treasuries. On Wednesday, the five-year and 10-year muni-to-Treasury ratios both closed below 100%. The five-year ratio closed at 98.9%, down from 113.8% on Monday. The 10-year ratio closed at 98%, down from 106.7% on Monday. The 30-year muni-to-Treasury ratio closed down to 121.3% from 129.4%.
In economic news Thursday, real gross domestic product grew at an annual rate of 1.8% in the third quarter, slightly below the estimated 2% expected. But it was higher than the final 1.3% annual rate of growth reported for the second quarter.
“The modest downward revision to real GDP growth was a result of slower growth in inflation-adjusted consumer spending than previously reported, offset somewhat by an upward revision to capital spending and less inventory liquidation than the preliminary data suggested,” analysts at RDQ Economics noted. “We believe the economy is on an improving trend and we look for fourth-quarter real GDP growth of around 3% and this report does nothing to change that.”
Initial jobless claims fell 4,000 to 364,000 for the week ending Dec. 17, the lowest since April 19, 2008 when claims were 352,000. The initial claims were lower than the 380,000 expected by economics.
“This is the second week in a row that initial jobless claims have been decisively below the 400,000 mark,” wrote analysts at RDQ. “These claims data suggest a marked slowing in the rate of involuntary separations and, therefore, point to a pickup in the rate of net job creation.”
When looking at defaults over the past year, Income Securities Advisors notes the latest numbers show 107 defaults with a par value of $24.6 billion. That compares to 169 defaults in 2010 with a par value of $5 billion. In 2009, defaults spike at 259 worth $9 billion. These include technical defaults when an issuer fails to make a payment on any obligation to a trustee.
MMD’s Daniel Berger noted that during this year, American Airlines accounted for $3.4 billion of municipal defaults while tobacco bonds made up $16.9 billion.
“Combined, American Airlines and the tobacco bonds comprised slightly more than 82% of municipal bond defaults,” he wrote. “Even though the volume of defaults has risen – and may continue to rise due to the presence of $100 billion of outstanding tobacco bonds – we do not believe that that there are systemic problems within the muni market.”
Looking forward to 2012, analysts at Morgan Stanley Smith Barney expect a 15% to 20% increase in supply. Credit spreads should tighten for A-rated general obligation and essential service revenue bonds, although the trend of downgrades out pacing upgrades should keep spread tightening to a slower pace, according to John Dillon, chief municipal bond strategist.
“The shape of the municipal yield curve is historically steep and we expect it to remain as such, with fed funds anchored until at least mid-2013 and muni buyers still focused primarily on the first 15 maturities of the yield curve,” Dillon said, adding that Morgan Stanley Smith Barney recommends six- to 14-year maturities.
Interest rate volatility coming from Treasuries shouldn’t change in 2012. “With Treasuries experiencing unprecedented volatility, municipal bond investors will need to closely monitor these benchmarks for favorable entry points,” he wrote.
Muni-to-Treasury ratios will be another concern. Dillon said he expects the 10-year ratio to remain at elevated levels in the early part of 2012 – hovering between 100% and 120% – and gradually decline to the 95% to 100% range later in the year.
“Municipals simply are not Treasuries and do not experience global ‘flight-to-quality’ flows which elevate the ratios,” he wrote. “Secondly, we have recently seen the longevity of the federal tax exemption ‘on the table’ when it comes to tax reform which makes it unlikely that municipal ratios will revisit the 84% long-term average any time soon.”
