The tax-exempt market started busy Tuesday morning but quieted down by the afternoon as traders left to start the Fourth of July holiday early.

With no primary issuance, munis struggled to find direction and ended the day flat.

"We are actually busy," a New York trader said early Tuesday.

Another trader said activity started to quiet down by afternoon. "It's very quiet," wrote Dan Toboja at Ziegler Capital Markets. "Desks are half-staffed, and trading is very light. Retail is shutting down for the holiday. With the early close, there likely will be no more trading."

Munis ended steady Tuesday, according to the Municipal Market Data scale. The 10-year yield finished flat at 1.85%. The two-year ended steady at 0.32% for the 23rd straight session, while the 30-year yield finished flat at 3.16% for the eighth session in a row.

Treasuries were weaker after a stronger session Monday. The benchmark 10-year yield rose four basis points to 1.63% while the 30-year yield jumped five basis points to 2.75%. The two-year was steady at 0.31%.

In the secondary market Monday, trades compiled by data provider Markit showed mostly firming.

Yields on Port Authority of New York and New Jersey 4s of 2022 dropped three basis points to 2.45% while Oklahoma Development Finance Authority 5s of 2042 fell two basis points to 4.32%. Yields on Pennsylvania 5s of 2023 fell one basis point to 2.27%.

Still, yields on King County, Wash., 5s of 2023 jumped four basis points to 2.28%.

So far this year, muni-to-Treasury ratios have risen as munis underperformed Treasuries and became comparatively cheaper, at least for short to intermediate maturities. The five-year ratio jumped to 111.4% on Tuesday from 98.9% on Jan. 3. The 10-year ratio rose to 113.5% from 96.4% at the start of the year.

Muni-to-Treasury ratios have fallen on the long end as munis outperformed Treasuries and became relatively more expensive. The 30-year ratio dropped to 114.9% on Tuesday from 119.4% at the beginning of January.

The slope of the yield curve flattened so far this year as demand outweighed supply. The one- to 30-year slope flattened to 296 basis points on Tuesday from 332 basis points at the beginning of the year.

When looking at the yield curve, analysts at Loop Capital Markets say the eight- to 16-year portion of the curve looks relatively cheap.

"Value is represented by the eight-, nine- and 13-year spots," wrote Chris Mier, a strategist at Loop. "Severe underperformance by the 14-, 15- and 16-year part of the curve over the last month suggests the potential for some mean reversion." The four-year spot is unusually rich, he added.

Credit spreads also compressed so far this year. The two-year triple-A to single-A spread compressed to 39 basis points on Tuesday from 56 basis points at the beginning of the year. The 10-year spread flattened to 79 basis points from 96 basis points at the start of the year. The 30-year spread dropped to 80 basis points on Tuesday from 89 basis points on Jan 3.

In part because of yield compression, muni analysts at Trident Municipal Research say they favor high-yield corporate bonds over high-yield muni bonds.

"TMR has been negative on the tax-exempt municipal high-yield market over the past several weeks," the analysts wrote. "Specifically, we have felt that with the corporate high-yield sector seeing yield spreads widen in the wake of JPMorgan's surprise announcement of trading losses, corporate offered a better risk-reward profile than high-yield municipals."

Since the beginning of June, high-yield municipals have underperformed high-yield corporates, according to the analysts. "Municipals have lagged the move in corporates more because of supply pressures, than because of rising investor fears of credit developments," they wrote. "So while the risk-reward picture is more balanced, we feel it is too early to allocate high-yield oriented capital back to municipals."

Indeed, muni exchange-traded funds have struggled so far this year compared to their corporate counterparts. The iShares S&P National AMT-Free Municipal Bond ETF — ticker MUB — rose 0.67%. The SPDR Nuveen Barclays Capital Short Term Municipal Bond ETF — ticker SHM — rose 0.28%. The PowerShares Insured National Muni Bond ETF — ticker PZA — increased 3.14%.

Muni ETFs underperformed the ProShares Ultra Seven to 10 Year Treasury ETF — ticker UST — which rose 7.54% so far this year.

Muni ETFs fell short of corporate bond ETFs. The iShares iBoxx High Yield Corporate Bond ETF — ticker HYG — rose 1.98% so far this year and the iShares IBoxx Investment Grade Corporate Bond Fund ETF — ticker LQD — increased 3.74%.

Analysts at Citi agreed that the market has recently handled large issuance very well and yields have remained fairly stable. "The lack of volatility in the muni market, in the face of extremely heavy supply by recent standards, has been impressive," wrote Citi muni analyst George Friedlander, adding the high-grade curve was essentially unchanged over the past week despite some volatility in Treasury yields. "Indeed, the muni market is at a point where both upside and downside volatility are likely to stay muted for awhile."

Friedlander added the next test for volatility could come after the heavy bond call season. "Bond calls and maturities tend to be heavy on June 1, July 1, and Aug. 1, followed by three months when calls and maturities are sharply lower," he said. "Given how important bonds calls and maturities have become as a source of cash for the purchase of new bonds, a sharp seasonal decline in calls and maturities could lead to some pressure on muni yields."

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