Municipal bond yields jumped Thursday after the Federal Reserve announced it will increase its tapering program. Puerto Rico bonds also softened.
While the Federal Open Market Committee announced yesterday it would reduce its monthly asset purchases by $10 billion in February, traders and analysts agreed that the market-moving effects of the Fed's tapering policy were priced in when the original announcement came last year.
"This move has been fairly corrective and could be signaling that while the market in munis is healthy, you have to determine how much risk off, risk on it's going to absorb the next couple months," one New York-based trader said.
The cheapest part of the curve is on the long end, the trader said, citing inflationary expectations as the reason for the low-priced bonds. The trader also noted a stronger presence in the secondary market
“I think the market has run into a little bit of a wall, we’ve had fairly good appreciation in basis points the last couple of months,” the New York-based trader said in an interview.
Many traders expressed the sentiment that the rally the past three weeks may have been overdone, and that bonds will now begin to settle at higher yields.
"We're in a bit of a saturated period for munis. While we're getting positive technicals, the market's getting a little bit ahead of itself in terms of directionality," the trader said. "Ratios can continue to tighten, but I'm not sure absolute levels have anywhere to go at this point."
Yields on municipal bonds maturing from 2022 to 2044 were pushed up by as much as two basis points, according to Municipal Market Data's AAA scale. Yields on bonds maturing between 2018 and 2021 jumped by one basis point.
Yields as measured by the Municipal Market Advisors 5% high grade scale were down by three basis points in 2035 and 2037 maturities. Yields on bonds maturing in 2018 and sooner were unchanged.
"The municipal rally we've seen in the early days of the New Year may be running out of steam, with a softer market tone Wednesday, and a second day of rising yields, particularly in the 8- to 12-year part of the yield curve," Janney Capital markets said in a report Thursday.
Volume this week could reach $4.89 billion, according to Bond Buyer and Ipreo data. Total bond sales last week came to $4.57 billion, according to Thomson Reuters.
"ICI reported a second week of modest mutual fund inflows last week (+$128 million), and anecdotal reports suggest a continuation of the positive direction when Lipper reports this week's flows later today," Janney said.
A Federal Open Market Committee held by the Federal Reserve yesterday brought news that the government's tapering of its bond-buying program would increase by $10 billion per month. Market participants expect the taper to push interest rates higher.
Treasuries were softer Thursday morning, with the 10-year yield up two basis points to 2.70%. The 30-year yield jumped one basis point to 3.64%, while the two-year was unchanged at 0.37%.
"We could have a significant shift start to occur in the Treasury market, "the New York-based trader said. "We rallied to a pretty good resistance point in treasuries and it seems like that's broken and could shift from risk off to risk on."
Puerto Rico bonds also tumbled into Thursday, with yields on the 10- and 30-year commonwealth general obligation climbing 22 basis points to 9.42% and 8.68%.
"GO yields are still too high as a default is just not realistic [in my opinion]," one trader in the southwest said in an email. "I think Puerto Rico slowly turns things around and a deal gets priced soon [either a COFINA sales tax bond or general obligation]. I think all of this panic about new PR supply is all hype and it will easily be absorbed and rally after pricing."
The trader, as well as other market participants, speculated that climbing yields in the last month of 2013 may have been a result of tax loss selling.
"I believe yields got out of hand to the upside late in the year as tax loss selling was all over the place and funds just wanted PR paper off their books at any price," the person said.
Puerto Rico general obligations have outperformed AAA-rated GOs as municipal bonds have rallied this month, according to yield curves.
Yield on 10-year Puerto Rico bonds has fallen 47 basis points since the beginning of the year, compared with about a 30 basis point-drop on AAA bonds with the same maturity. Puerto Rico bonds maturing in 30 years have fallen 22 basis points.
"I really think COFINA's are the bargain of the decade and they should rally 100-200 basis points just to be fairly valued in my opinion, trading at 6 to 8 levels below their rating is just not reality," the trader said.
In other economic news, initial jobless claims climbed 19,000 to 346,000 in the week ended January 25, the Labor Department said Thursday. Claims for the week ended January 18 were revised up to 329,000 from the initially reported 326,000.
