NEW YORK – The tax-exempt market rallied for a third day Thursday, erasing almost all of the losses that hit munis the end of last week. Market participants that thought munis couldn’t handle this week’s supply were proven wrong, as deals in the primary market were priced well and the secondary market is showing huge gains.
“Munis were very well received this week,” a trader in Chicago said. “The supply is the most baffling question for me. It keeps bouncing around and there are huge savings to be had by the municipalities and I just don't see any coming. There is no supply at all in decent secondary blocks but everyone is looking for bonds.”
A New Jersey trader had a tone of frustration as well. “It seems like the market is feeling cyclical,” he said. “It didn’t feel well, and then it rallied and came back. So it’s frustrating in that way.”
He added there was buying when new deals came to market and most were very well received. He noted a New York City Municipal Water Finance Authority bond with a 5% coupon came to market at 3.95% on Tuesday and it is trading on the secondary at 3.80% Thursday. So, “the secondary is firmer Thursday.”
“Deals are going very well,” a New York trader said. “There are a lot of bid-wanteds but nothing is trading. Dealers are trying to get ‘price discovery’ for their clients.”
Munis rallied on the limited supply that did come Thursday and prices were bumped across the curve, according to the Municipal Market Data scale. Yields inside three years were steady, while yields on the four-year to 10-year fell as much as two and three basis points. The 11-year yield fell four basis points while the 12-year to 22-year yields dropped five basis points. Outside 23 years, yields fell three and four basis points.
On Thursday, the two-year muni yield closed steady at 0.35% for its 10th consecutive trading session. The 10-year and 30-year muni yields fell three basis points each to 1.79% and 3.27%.
Treasuries gained as yields fell to weekly lows. The two-year yield fell two basis points to 0.22%. The benchmark 10-year yield dropped five basis points to 1.94% and the 30-year yield fell three basis points to 3.10%.
In the primary market, Bank of America Merrill Lynch priced $368.2 million of Illinois Finance Authority revenue bonds for the University of Chicago. This deal comes after the university priced $190 million of taxable fixed-rate bonds Tuesday. The bonds are rated Aa1 by Moody’s Investors Service, AA by Standard & Poor’s, and AA-plus by Fitch Ratings.
Yields ranged from 0.15% with a 2.5% coupon in 2012 to 3.90% with a 5% coupon in 2051. The bonds are callable at par in 2021.
In the secondary market, trades reported by the Municipal Securities Rulemaking Board showed firming in just one day of trading.
A dealer sold to a customer Greater Arizona Development Authority 5s of 2035 at 3.33%, 18 basis points lower than where they traded Wednesday.
Bonds from an interdealer trade of Wisconsin 5s of 2027 yielded 2.57%, 15 basis points lower than where they traded the day prior.
A dealer sold to a customer Port Authority of New York and New Jersey 4s of 2033 at 3.68%, nine basis points lower than where they traded the previous day.
Another dealer sold to a customer Puerto Rico Sales Tax Financing Corp. 5s of 2040 at 4.02%, six basis points lower than where they traded Wednesday.
Muni-to-Treasury ratios on the short end of the curve jumped this week as munis underperformed Treasuries. The five-year ratio catapulted to 100% on Thursday from 91.2% on Monday. The 10-year jumped to 91.5% from 90.8%. The 30-year muni-to-Treasury ratio fell slightly to 105.8% on Thursday from 107.3% on Monday.
Even though the muni rally took a three-day hiatus late last week, the 10- to 30-year slope has flattened significantly. On Thursday, the slope was 148 basis points, down from 169 basis points at the beginning of the year. And with the rally picking up steam again this week, the slope flattened from 150 basis points.
Looking back at the significant weakening munis experienced last week, Citi analysts say this is not the beginning of a long period of losses.
“The question now is whether the back-up in yields is sufficient for the market to clear as new issue supply rebounds,” analyst George Friedlander wrote. “We suspect that a modest additional rebound in yields may be needed but that this is not the start of a very substantial correction or the beginning of a new upward trend in rates.”
One factor that is supporting munis is the collapse of short-term yields, including this week’s Federal Open Market Committee announcement that yields will stay at zero to 0.25% until 2014. The low short-term yields pushed muni investors to put money to work further out on the yield curve.
Lack of new supply should also support the muni sector as it creates the impression there is more demand. With bonds calls and maturities, Friedlander estimates the total amount of outstanding bonds fell by $85 billion in 2011.
Muni bond fund flows have also turned positive for the past consecutive eight weeks. “The sheer scarcity of paper in the secondary market as the year started also helped, as did the willingness of dealers to restock as the New York commenced, but with little for dealers to choose from,” Friedlander said.
And while these factors should generally support the municipal market, another correction could be waiting in the wings when supply picks up again. “Based on our outlook for refundings and the fact that new money issuance for projects was abnormally low last year, we believe full-year issuance could be up 15% to 18% and that could put pressure on absolute and relative yields,” he said.