Municipal bonds posted their biggest first-quarter gain in five years.
The market gained 3.3% from January through March 31, the most in any first quarter since 2009, when bonds returned 3.6%, according to S&P's National AMT-Free Municipal Bond Index.
"The key drive for first-quarter gains is investors recognizing municipal yields got relatively too cheap compared to other asset classes going into 2014," J.R. Rieger, vice president of fixed income at S&P Dow Jones Indices, said.
Rieger said yields for the tax free municipal bonds going into 2014 were 3.11% while yields for corporates were 3.1%.
"We were right on top of corporates. So that means munis were relatively cheap compared to corporates at the time," Rieger said.
Long duration tobacco bonds had the greatest returns of any sector at 8.36%, Rieger said.
"Tobacco and Puerto Rico are leading upward for the year still," Rieger said. "The Puerto Rico index is up 7.42%."
The S&P tax-free municipal index slipped 0.13% in March, the smallest decline for the month since 2008. when it gained 2.36%.
Market participants said that low issuance has fueled investor demand this quarter.
"There has been a substantial rally towards the end of the quarter," a trader in New York said.
There were $62.48 billion in bond sales in the quarter, compared with $84.43 billion a year earlier, according to data provided by Thomson Reuters. New issuance in March dropped to $27.63 billion from $32.75 billion last year.
"A lot of issuance was squeezed out at the end of last year" which"stole some of the supply," Robert Donahue, managing director at Municipal Market Advisors, said in an interview. "We are having a slow start."
This year's positive municipal fund flows also display investors' demand. There have only been four weeks of outflows out of 12 weeks so far this year.
"You have seen money come back into funds," said Rieger. "But there are no bonds to buy. So fund managers have to put money into the secondary market because they cannot sit on cash."
Weekly municipal fund flows have reached as much as $333.6 million this year. Funds also posted six-straight weeks of positive results from the week ending Feb. 12 to March 19, until fund flows went negative for the week ending March 26, after Federal Reserve chair said the Fed may raise interest rates as soon as the middle of next year.
"Just based on investors perception, munis having a strong first quarter will invite more investors in to chase any ongoing price momentum," Matthew Fabian, managing director at MMA, said.
Rieger said that there were many pressures on the municipal market in 2013 with Detroit filing for bankruptcy, troubles with Puerto Rico, and questions about tobacco.
"There was a heavy news presence at the end of 2013, but now for 2014 we have the first quarter in the basket," Rieger said.
This week's total potential volume is slated at $4.19 billion, down from $4.78 billion issuance last week.
"We don't have a huge calendar in front of us," a trader based in New York said.
On Wednesday, $120 million Lincoln Public School District, Neb., general obligation bonds will be auctioned in the competitive market.
In the negotiated market, an issue of revenue financing system bonds for the University of Texas was increased to $259.1 million from $258.3 million. Yields ranged from 0.15% with a 2% coupon in 2015 to 3.80% with a 5% coupon in 2044.
The bonds, which mature serially from 2015 to 2036, with terms in 2042 and 2044, are callable at par in 2024 and rated Aaa by Moody's Investors Service and AAA by both Standard and Poor's and Fitch Ratings.
Goldman Sachs brought to market a three-part deal totaling $264.4 million for the San Diego School District. Yields on $15.1 million of dedicated unlimited tax ad valorem property tax GO bonds ranged from 0.10% with a 1% coupon in 2014 to 0.43% with a 5% coupon in 2016. The bonds are not callable.
Yields on $50 million of dedicated unlimited tax ad valorem property tax GO bonds ranged from 41.48% with a 5.18% coupon in 2031 to 26.39% with a 5.58% coupon in 2038.The capital appreciation bonds are callable at par in 2024.
Yields on $199.3 million of refunding bonds ranged from 0.18% with a 2% coupon in 2015 to 3.39% with a 5% coupon in 2029. The bonds are callable at par in 2024.The deal is rated Aa3 by Moody's and AA-minus by S&P.
The Louisiana Local Government Environmental Facilities and Community Development Authority issued $209.8 million of subordinate lien revenue bonds for the East Baton Rouge Sewerage Commission projects. Yields ranged from 3.21% with a 5% coupon in 2025 to 4.34% with a 5% coupon in 2044. The bonds are callable at par. The deal is rated A1 by Moody's, A-plus by S&P and AA-minus by Fitch.
Yields on munis maturing in 2025 and later rose as much as two basis points, according to the Municipal Market Advisors 5% triple-A scale.
Muni yields on bonds maturing from 2021 to 2039 jumped as much as two basis points, while yields on bonds maturing beyond 2040 climbed as much as three basis points, according to the Municipal Market Data scale. Short-term bonds held steady.
Treasury yields were steady, as the 30-year and the 10-year benchmark were unchanged at 3.60% and 2.76%, respectively. Two-year notes fell one basis point at 0.45%.
