Investors have started looking to bonds with 4% coupons for better priced deals.
"There is some value in some 4% versus 5% coupons," Fred Bacani, head of fixed income & trading at Veritable LP in Newtown Square, Pa., said.
Issuance has remained low this year, totaling $89.34 billion as of April 30, compared to $122.7 billion for the same period in 2013, according to data provided by Ipreo and The Bond Buyer. Investors have said that bonds coming to market are being priced unusually high.
This is especially true for bonds with a defensive 5% coupon, investors say. Market participants said this was because investors were buying the 5% coupon to protect themselves from possible interest rate increases.
"Lots of investors are piling into 5% defensive coupon in a rising rate environment, they are getting a lot of demand," Bacani said. "We see value in the 4%, 4.5% coupons."
At the beginning of the year the Federal Reserve said that it would look to raise interest rates when unemployment reached 6.5%. In March Federal Reserve policy makers said that 6.5% was no longer an exact benchmark for when they would raise interest rates, and that they would focus more on the underlying economic data.
"The Fed is not giving the market direction because it does not know or has not been in a situation like this," a trader in California said.
On May 2 the employment situation report showed that unemployment dropped to 6.3% in April. Then on Wednesday Federal Reserve Chairwoman Janet Yellen said that the Fed was not going to change it's interest rate policy in the near future and look to the inflation rate and housing numbers as an indication for when to raise interest rates.
The trader in California said that despite these assurances, market participants are still concerned about rising interest rates.
"Maybe there is not volatility in the market right now, but people are confused," he said. "The Fed is confused, investors are confused. Cross currents have never been more confusing geo-politically, half the world is on fire."
A trader in Virginia said this is why demand has surged for safe bonds.
"With rates as low as they are we've been seeing pretty large premiums on 5% coupons," he said.
A trader in New York said that if he invests below the 5% coupon mark, he is ideally looking at 4% coupons or 4.5% coupons if the dollar price is low.
"I'm very careful with 5% coupons, they command a pretty big dollar price at some points it gets to where that dollar price eats into your interest payments," he said New York said. "I will do 4% coupons and 3% coupons if the maturities are not too far out on the curve, so you don't get murdered if interest rates do go up -- bond maturing in under 12 years."
A seconder trader in New York said that he has mostly seen institutional investors purchasing bonds with lower than 5% coupons.
"There have been a number of buyers, particularly institutions, that will buy 4% on the long end," he said. "They are looking at the long end because they are basing their purchases on the absolute yield differential, and the yield pick-up they will receive. There is a little more value vs. treasuries on the long-end in particular."
A trader in Chicago said that a lot of the newer deals are coming with 3%.
"Investors are kind of handcuffed if they want a 5% coupon," he said. "To get one they will have to buy [something] like an Illinois name, and they probably would rather not do that. There was a big Nevada State GO deal done a couple of months ago around 3%. People are pretty desperate for yield, especially on the long-end."
Dan Heckman, senior fixed income strategist at U.S. Bank, said in an interview that it is beneficial for investors to diversify their portfolio, coupon wise.
"I do think we're at a point where a balance of coupon varieties from 4% to 5% is very good to have in a portfolio," he said.
He cautioned against going too far below the 5% coupon, because he said those coupon payments are useful if interest rates do begin to rise.
"If investors do want to buy lower coupon bonds, if they are trying to ladder out their portfolios, have lower than 5% coupons in short part of portfolio and maintain higher coupon in longer end," he said. Coupons of 5% "pay higher dividends if rates start rising a bit."
Market participants said munis were firm on Monday, but the market was pretty quiet. Yields held steady throughout the curve, according to Municipal Market Data's triple-A scale.
Municipal Market Advisors also reported that yields did not move from Friday with the two-year remaining at 0.35%, the 10-year at 2.28%, and the 30-year at 3.54%.
There are several large deals scheduled to hit the market on Tuesday, the biggest of which is the $1 billion of New Jersey Turnpike Authority revenue bonds. The lead underwriter on the deal is Goldman, Sachs & Co.
The market was pretty quiet on Monday, investors said. In the secondary trading market Puerto Rico yields did rise 22 basis points to 8.98% on Monday, according to Bloomberg data.
Yields began rising after Puerto Rico reported that its corporate tax collection for April came in $380 million short of its government's projections, and total revenues for the month were 26% below expectations.
"From what I've been hearing —one of our people on the desk trades a fair amount of Puerto Rico — the revenue came in below expectations," the second trader in New York said.
He said the low revenue is why the market has backed off from the Puerto Rico paper a bit and why there has been a sell-off on the 8% coupon GO.
Treasuries weakened Monday, with the 30-year yields jumped two basis points to 3.49% and the 10-year benchmark climbing three basis points to 2.66%. The two-year notes inched up one basis point to 0.41%.
