Municipal bond issuance at decade lows may prevent tax season from driving down demand for bonds in March and April.
The market is still playing catch-up following a week of heavy supply, market participants said, meaning the demand drought that typically comes as investors pay their taxes may subside this year.
"I think this year will be different," a financial advisor on the west coast said. "I think it will be a situation where we will not see demand for municipal bonds softening. If there is a drop in demand, it will be relatively minor because supply is just not around, in terms of the issuance we have had this year."
Total issuance for January and February was down roughly $18 billion from a year earlier, according to The Bond Buyer data. There were $33.7 billion of new bonds in those two months, compared with $51.7 billion in 2013. The market had an uptick last week as Puerto Rico and California led more than $11 billion in sales.
While demand in January and February was strong, March traditionally brings some weakness as taxes due April 15 cause demand to wane, BlackRock said in a report Monday.
"Muni seasonals tend to weaken in mid-March as issuance increases and typically lasts until mid-April," Carney said in an email. "It tends to be a period where investors are focused more on paying their taxes than adding to their muni portfolio."
The curb in demand may be less pronounced this year, Carney said.
"The impact may very well be muted this year given a 30-day forward calendar that represents a below average supply week, never mind a couple-week look at issuance," he said. "It is typically the very front end of the curve that experiences this weakness. SIFMA [swap index] tends to rise, but will quickly correct".
Municipals' tax-exempt status might actually make the bonds more appealing during tax season, according to Michael Schroeder, president and chief investment officer at Wasmer, Schroeder & Company. In states where the income tax is high and going up there is a more elevated demand for tax-exemption.
"[Investors] are going to look at their income tax rate and say, 'maybe I'll take a look at munis'," Schroeder said.
In addition to the lack of issuance in 2014, the implementation of President Obama's Affordable Care Act may contribute to investor interest in tax-exemptions.
"Part of what's going to happen is that people are seeing they are paying higher taxes [due to the Affordable Care Act]," the West Coast-based financial advisor said. "That will keep demand for municipals up there. Unless we have a surprise in terms of issuance we won't see any changes."
Municipal traders and analysts said it is unclear yet how the rollout of the healthcare law may affect municipals. While some say higher taxes on investors means more interest in tax-exemption products, others said uncertainty overall weakens markets.
"Healthcare overhaul is an uncertainty and anytime you introduce something that you can't quantify with a high certainty level, that translates into caution, which translates into impediments on the demand side for any asset class," Schroeder said.
Issuance was light on Monday, with no deal totaling over $100 million in either the negotiated or competitive sides of the market. There is $3.28 billion of potential issuance scheduled for this week, a 71% drop from last week's $11.4, according to data compiled by Ipreo and The Bond Buyer.
"This week's supply returned to below average issuance and should be absorbed well," BlackRock's Carney said. "Anything with spread will do well. It would be a large high quality benchmark deal that has the ability to get hung up if anything could."
Yields on Puerto Rico and California's general obligation bonds, the two biggest issuances last week, softened on Monday.
After plunging more than 40 basis points from the issue price on the second day of secondary trading, Puerto Rico general obligation bonds ended Monday with a yield of 8.62% for bonds with an 8% coupon maturing in 2035, or 11 basis points less than the initial yield.
"We definitely saw Puerto Rico soften a bit, and we think it got way ahead of itself last week," a financial advisor on the west coast said in an interview. "The people who bought them last week bought them at much higher levels and jumped in too quickly."
California GOs ended Monday with yields of 3.07% for bonds with a 5% coupon maturing in 2025. The bonds, issued Feb. 12, firmed by 12 basis points the day the deal became free to trade.
Yields were steady on Monday, according to Municipal Market Data, with bonds maturing from 2021 to 2035 weakening by as much as one basis point.
Treasuries jumped, with the 30-year yield and the 10-year benchmark rising one basis point each to 3.63% and 2.70%, respectfully. Two-year note yields gained two basis points at 0.38%.
The secondary market was mostly firmer Tuesday, according to Markit.
Yields on Tobacco Settlement asset-backed bonds with a 4.63% coupon maturing in 2026 fell two basis points to 2.09%, while San Antonio, Texas lease revenue bonds with a 4% coupon maturing in 2042 slid four basis points to 4.64%.
