NEW YORK – There were more buyers than sellers in Wednesday’s tax-exempt market, compressing spreads and pushing the market firmer. Traders looked to the secondary for direction as the primary offered no supply this week.
“It definitely feels like spreads have tightened because there is no supply,” said a Los Angeles trader. “I’m telling bankers here that if you have a deal, bring it. Because the market wants product and there is a lot of pent up demand.”
He added that normally, spreads would have widened as traders came back from vacation with the Municipal Market Data scale near record lows. “But that’s not happening,” he said. “Spreads are tightening and activity is building back up from a three-quarters week. We expect to go full blast next week.”
Munis were mixed through the day. In the morning, retails buyers flooded in the market. “Retail is buying, but some dealers are looking to lighten up,” said a trader in New York.
By afternoon, trading activity had picked up as customers were looking to put January reinvestment money to work.
“I held a few things back from the street earlier,” said a trader in Chicago. “But I put things back out to bid and got strong bids. Yesterday was dismal but things are swamped today and getting firmer.”
He added that the problem is there is no selling pressure, due to the fact that customers want to put that cash to work. “So some of it is street bonds trading hands so how much of that can you do?”
“All in all people are looking for bonds,” he said.
On Wednesday, munis were mixed, according to the MMD scale. Yields inside the five-year were steady while yields on the six-year and seven-year bonds rose one basis point. Yields on the eight-year to 14-year were steady. Yields on the 15-year to 19-year fell one basis point and the 20-year to 21-year yields dropped two basis points. The 22-year yield fell one basis point while yields outside the 23-year were unchanged.
The two-year finished flat at 0.42%. The 10-year yield closed steady at 1.88% and the 30-year finished at 3.57%.
Treasuries were weakening across the curve. The benchmark 10-year yield increased three basis points to 1.99% while the 30-year yield jumped five basis points to 3.04%. The two-year yield was steady at 0.27%.
In the primary market Wednesday, one of only four negotiated deals on the calendar came to market. RBC Capital Markets priced $8.8 million of Pennsylvania’s Green Township Municipal Authority bank qualified bonds, rated Aa3 by Moody’s Investors Service. Pricing information was not available.
On the competitive calendar Wednesday, Morgan Stanley won the bid for $43.7 million of Little Rock, Ark., School District bonds. The credit is rated Aa3 by Moody’s.
Maturities on the credit ranged from 2014 to 2033. Coupons ranged from 2.00% to 3.75%. The bonds were not formally re-offered. The bonds are callable at par in 2017.
In the secondary market, trades reported by the Municipal Securities Rulemaking Board showed firming when compared to last week.
A dealer sold to a customer Dallas Area Rapid Transit Authority 5.022% of 2048 at 4.28%, 12 basis points lower than where they traded the week prior.
Another dealer sold to a customer Commonwealth of Puerto Rico 5s of 2023 at 5.00%, three basis points lower than where they traded last week.
Bonds from an interdealer trade of Massachusetts 4.2s of 2021 yielded 2.91%, two basis points lower than where they traded the previous week.
In the secondary, “2012 trading was in full swing” according to MMD’s Randy Smolik. “With no primary issuance to speak of, January re-investment was focused on the secondary and two-way flows are building. We have seen various preferences of customer buying that was causing certain sectors to stay firm or perform better.”
In terms of ratios, MMD think the five-year spot is the cheapest. The current five-year muni-to-Treasury ratio is 100%, which is higher than the 12-month average of 92.9%. “This is where we can see some outperformance during the foreseeable future should this ratio revert back to its mean,” said MMD’s Daniel Berger.
As of Wednesday, the 10-year ratio was 96.4% and the 30-year was 119.4%.
Others agree. “Rising long-term Treasury rates, corporate credit spread tightening, and negative net muni supply all favor munis outperforming Treasuries on a ratio basis,” wrote John Hallacy, municipal research strategist at Bank of America Merrill Lynch. Based on these factors along with forecasting, “the best absolute performance would be in the five-year part of the curve, while rising long-term Treasury rates may pressure the 10-year and 30-year parts of the AAA muni curve higher.”
Looking forward to 2012, many analysts are expecting new municipal issuance in 2012 to be higher than 2011, but not as high as previous years. Bank of America Merrill Lynch is expecting about $330 billion, “given the economy is moderately improving and state and local budget gaps are not considered to be as significant going into this cycle,” Hallacy wrote. Also, the expectation of continued low interest rates mean “financing rates and refunding rates remain attractive and should serve to attract more issuers to market.”
Hallacy also examined issuance patterns during election years. “More often than not, volume in the Presidential election year is more modest or is only marginally higher than in the prior three years.”
Predictions also estimate that rates will be lower in the first half of 2012 than in the second half. Because of that, refunding activity is expected to be stronger in the first half and moderate as the year progresses.
Most bonds also have a 10-year call protection. About $172 billion of fixed-rated munis were issued in 2002, allowing them to be called this year. Hallacy said $125 billion of that is still outstanding.
For potential returns, Hallacy looks at 5% coupon bonds with a 10-year par call for maturities greater than 10-years, and 5% coupons on non callable bonds. Looking at those two factors, the seven-year part of the curve should see the best performance along with the long-end of the curve for callable bonds maturing after 10-years.
“After have outperformed the last two years, the seven-year to 12-year part of the curve may be poised to underperform on the outlook for rising rates,” Hallacy noted. “In this environment, we have five-year to seven-year munis.”
