Market Close: Munis Soften Approaching Year-End

The market for tax-exempt municipal bonds weakened Friday following a weeklong softening in Treasuries. Activity picked up with traders returning from holiday but remained low overall, traders said.

"We've seen a couple of trades today, it's not overwhelming," one trader in Chicago said in an interview.

Yields on bonds maturing from 2018 to 2023 were softer, the trader said, with higher-grade bonds performing well.

According to the Municipal Market Data triple-A scale, yields softened. Bonds maturing in 2017 and from 2019 to 2023 saw the biggest gain in yield with a two basis-point jump.

Yields on bonds maturing from 2019 to 2026 rose as much as two basis points, and those maturing from 2032 to 2043 gained up to one basis point, according to the MMD scale.

Yields on the Municipal Market Advisors 5% AAA benchmark scale rose by a basis throughout the middle of the curve, on bonds maturing as early as 2021 and as late as 2031.

The 10-year Treasury yield hovered around 2.99% after touching 3% Thursday. Yield on the thirty-year Treasury gained one basis point to 3.93%, while two-year dipped two basis points to 0.4%.

"We'd all be better off calling football pools instead of trying to read the market," one Chicago-based trader lamented in an interview. "People out and a lack of supply has thrown a cold blanket over munis."

Issuance was very low in the holiday week, with revised sales at $17 million, down from total sales of $2.80 billion in the week ended Dec. 20, according to Thomson Reuters data. There are no new issue bonds slated for the coming week.

"The equity profits and bond market losses generated in 2013 have created opportunities for tax minimization not seen in many years," Janney Capital Markets said in its daily report.

With no new supply before year end, and the 30-day visible supply below $4 billion, pressure on the municipal market is minimal, save for the continuing mutual fund outflow trend."

Trading in the market was practically non-existent at the end of the week, Janney said, with just some year-end tax selling and tax swapping taking place. Janney said the trend is likely to continue through to the New Year's Eve deadline for 2013 loss realization.

"It's going to be dead going into the first week of January since most desks will only be half-staffed," the trader said. "January doesn't really get started until the second or third week and people who couldn't issue debt last year will see how rates are affected by the taper."

Market participants agreed that the Federal Reserve's announcement that it will begin tapering its quantitative easing policy did not have a prominent effect on munis during the week.

Many traders did voice concerns, however, that rising treasury yields may contribute to a further softening of municipals in the weeks to come.

Trades in the secondary market showed munis had mixed performance Friday, according to data provider Markit.

New York World Trade Center development revenue bonds with a 5% coupon maturing in 2044 jumped three basis points to 5.08%, and Puerto Rico Highway and Transportation Authority bonds with a 5% coupon in 2046 gained two basis points to 8.87%.

Los Angeles Water System revenue bonds with a 5% coupon in 2043 firmed by three basis points to 5.52%, and Washington state various purpose general obligations with a 4% coupon in 2029 slid two basis points to 4.16%.

Outflows from municipal bond mutual funds continued into the 31st straight week.

Also persistent outflows into 12/31 are keeping institutional desks busy while tax swaps are keeping retail operations occupied," Municipal Market Advisors said in a Dec. 23 report. "Fund outflows have increased lately, likely in tune with worry over Puerto Rico's Rating Watch for Downgrade by Moody's."

Muni bond funds that report flows weekly saw outflows of $1.49 billion for the week of Dec. 25, down from $1.71 in the week prior, Lipper FMI numbers showed.

"If outflows persist at the current, heavy pace after Dec. 31, the ultimate pivot back to fund inflows may be farther off than expected," MMA said. "In our view, it is only after that pivot that credit spreads can begin to re-tighten and more normal liquidity begin to re-emerge in market operations."

MMA's Matt Fabian said in an interview Monday that 2014 is shaping up to be another tepid year for munis.

"Looking forward, it shouldn't be much worse but it doesn't look to be brilliant either," Fabian said. "Understanding the market context is critical to know why things matter and when."

Fabian said that 2013's most notable rough patches may not have fundamentally been as negative under different circumstances, saying that Jefferson County's bankruptcy in 2012 was not as impactful as Detroit's since the market environment was different.

"Jeffco had some rather systemic issues coming out of it but there was almost no reaction given the scarcity of bonds in the market and steadily lower yields," Fabian said.

Understanding how munis will react to distress in 2014 will depend on how the Fed's taper and regulations affect the muni industry on the whole, Fabian said.

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