NEW YORK – Tax-exempt investors don’t seem to mind investing in a market when yields across the curve are at or within reach of record lows. Demand was strong in the new issue market and secondary trading was firm.
“We saw better buying in the morning and now we are going into weekend mode,” a trader in New York said. “The market was pretty much a better bid all day. And whatever we show to people, they buy.”
He added that because of low yields, “the market is climbing a wall of worry – no question.” But the sell-off may not come soon. “Right now the market is overwhelmed by positive technicals so a lot of people want to turn cautious but the market keeps rallying because people were too cautious for too long.”
“It’s not surprising that new issues are seeing strong demand,” a second New York trader said, referring to the many deals this week that were moved up a day and well subscribed to. “Munis are still cheap to Treasuries and coupon payments and redemption money has to go somewhere, even if absolute yields are unattractive.”
Party because of these extremely low yields, the trader said, “I have not been a participant, really just a spectator so far this year.”
Munis were mostly firmer Thursday, according to the Municipal Market Data scale. Yields inside five years fell up to two basis points while the six- and seven-year yields were unchanged. The eight- to 13-year spot was the part of the curve that was weaker, with yields rising one basis point. Outside 14 years, yields fell up to three basis points.
On Thursday, the two-year yield closed steady at 0.30%, matching its record low set Oct. 10. The five-year muni yield set a new record low of 0.66%, beating its previous record of 0.68% set Wednesday. The 30-year yield fell three basis points to 3.14%, tying its record low set Tuesday.
The 10-year muni yield was the anomaly, rising one basis point to 1.69%, closing two basis points higher than its low of 1.67% set Jan. 18.
Treasuries were mostly steady. The two-year and 30-year yields closed flat at 0.23% and 3.02%, respectively. The benchmark 10-year yield fell two basis points to 1.83%.
The primary market was quiet Thursday as most deals were pushed up a day early to Wednesday.
In the secondary market, trades reported by the Municipal Securities Rulemaking Board were mixed, but the majority of the trades showing firming.
Bonds from an interdealer trade of Nebraska Public Power District 5s of 2031 yielded 3.12%, six basis points lower than where they traded Wednesday.
A dealer bought from a customer Municipal Electric Authority of Georgia 6.637s of 2057 at 5.66%, six basis points lower than where they traded Wednesday.
A dealer sold to a customer New York City Municipal Water Finance Authority 5s of 2044 at 3.67%, one basis point lower than where they traded Wednesday.
Muni-to-Treasury ratios have fallen this week as munis outperformed Treasuries. The five-year ratio closed at 93.2% on Wednesday, down from 97.3% on Monday. The 10-year ratio fell to 91.3% from 92.4% and the 30-year ratio dropped to 105.3% from 106% on Monday.
The slope of the curve steepened so far this week to 149 basis points, up from 146 basis points on Monday. The slope is still relatively flat compared to the beginning of the year when it was at 169 basis points.
When comparing the slope to the one-year and three-year averages, the slope is fairly steep, according to John Hallacy, municipal research strategist at Bank of America Merrill Lynch, but he doesn’t expect it to flatten anytime soon. “Muni rates are likely to stay within current ranges for the next few weeks until we get a meaningful pickup in supply.”
Munis had an “impressive” January, returning 1.71% as of Jan. 25, according to the Bank of America Merrill Lynch U.S. Municipal Master Index. Treasuries returned a negative 0.446% for the same time period.
The long end of the curve did far better than the short end. As of Jan. 25, munis outside 22 years returned 2.637% followed by 12- to 22-year maturities which returned 2.344%. The seven- to 12-year index returned 0.985% while the three- to seven-year index returned 0.585%. Munis inside three years returned only 0.209%.
Hallacy added that analyzing returns by municipal ratings showed the BBB category had the best return for the month at 2.375%.
In terms of issuance expected for 2012, Peter DeGroot, analyst at JPMorgan, said January is a decent indicator of full-year supply. Issuance for January is expected to come in at about $19 billion, which is 53% above January 2011 but 17% below the 10-year average supply for the month.
“Based on 10- and 20-year regressions, January’s volume suggests full year 2012 issuance of $324 billion to $355 billion,” DeGroot noted. “This is relatively in-line with our $350 billion full-year 2012 volume estimates and, coupled with continued low yields, is supportive of prolonged manic market conditions.”
DeGroot added that with these low yields, investors are better off supplementing low high-grade yields with intermediate-term lower grades bonds. That alternative is better than extending into longer-dated callable high-grades, he said. “A-rated spreads to the AAA scale are at their widest levels of 93 basis points in the 11- to 20-year points on the curve.”
DeGroot also recommends overweighting the eight- to 13-year sector of the yield curve to capture out-sized curve roll and strong liquidity. Except for the 10-year spot, the belly of the curve offers 369 to 454 basis points of expected return. “These points on the curve exhibit better liquidity, tax-risk, and interest rate risk versus similar performing maturities.”