Prices of top-rated municipal bonds moved lower yet again, as yields on some bonds closed two basis points higher on Thursday. Since Monday, yields on the 10-year have risen by 12 basis points while yields on the 30-year have risen by 16 basis points.
Yet even after the recent volatility in the market, munis continue to exhibit attractive characteristics for investors.
"The relative value of municipal bonds is one of the high points we have going for us in the municipal bond market," says John M. Dilllon, Managing Director at Morgan Stanley Wealth Management. "And when you get to these levels, people start to pay attention."
Muni-to-Treasury ratios are just one data set that point to munis as a good investment, according to Dan Berger, Senior Market Strategist at Municipal Market Data.
The ratio is calculated by taking the yield on a triple-A rated muni and comparing it to the yield on a Treasury of a similar maturity. The higher the ratio, the more value tax-exempts have relative to Treasuries.
"During the past two weeks, munis have displayed underperformance relative to Treasuries," Berger says. "The muni to Treasury ratios have hit 12-month highs: for the 10-year range, the peak of 104.2% was reached on Monday, while the high of 111.1% in the 30-year range was evident last Friday."
When used in combination with different measures, the ratio can be a useful tool for investors and fund managers in gauging the relative value of munis to other investments.
On Thursday, the 10-year muni-to-Treasury ratio stood at 102.8%, while the 30-year muni-to-Treasury ratio was at 109.9%.
"On the heels of an impressive 2014, in which tax exempts returned over 9% according to Barclays, the asset class is again enjoying the forward momentum of the U.S. Treasury market," Morgan Stanley Wealth Management said in a recent report on the state of the market. "But unlike mid-2014, which brought outperformance versus USTs, tax exempt yield declines have since lagged USTs due to a confluence of factors."
Among the factors Morgan Stanley cited:
Municipals don't generally enjoy global inflows during periods of uncertainty; a Republican-controlled Congress suggests that tax reform rhetoric and possibly even legislation may surface during 2015 (though the firm sees the probability of passage as rather low); a new-issue calendar that has ramped up more quickly than usual (raising concerns about too much supply); and new, lower, absolute yield levels that have broken below psychologically important benchmarks (and buyers may be slow to embrace).
The muni market has posted a 1.3% year-to-date total return, according to Barclays, so Morgan Stanley feels that a repositioning of portfolios is warranted.
"The market has come a long way in a short time. Oil has plunged, low inflation expectations are largely 'baked in' and the yield curve has flattened," Morgan Stanley says. "We are now moving to a short-duration bias."
The firm says its new focus is on 10- to 15-year maturities, cash and floating rate notes.
"We favor above-market coupons and continue to suggest mid-A (and higher) ratings for general obligation bonds and mid-BBB (and higher) for essential service revenues," Morgan Stanley says.
Looking ahead, munis may see a reversal of fortune as the year progresses.
"Munis are cheap on a relative value basis," Dillon says, "But if you look forward, munis may very well outperform."
Berger agrees that opportunities exist right now to find value.
"Despite this volatility, astute investors will spot an opportunity for muni outperformance as these ratios should revert back to their 12 month average," he said.
Secondary Market
Prices of top-rated municipal bonds moved lower with Treasuries for the fourth day in a row.
The yield on the muni 10-year benchmark general obligation rose two basis points to 1.86% on Thursday from 1.84% on Wednesday, while the yield on 30-year GOs increased two basis points to 2.66% from 2.64%, according to a final read of Municipal Market Data's triple-A scale.
Treasury prices were lower. The two-year note yield rose to 0.52% from 0.51% on Wednesday; the 10-year yield increased to 1.81% from 1.79%, while the 30-year yield rose to 2.42% from 2.38%.
Primary Market
The new issue sector was relatively quiet on Thursday as the market digested the heavy new issuance seen earlier in the week. Morgan Stanley priced Los Angeles, Calif.'s Department of Airports $499.125 million of revenue bonds.
The $268.08 million Series A alternative-minimum-tax senior revenue bonds were priced to yield from 0.35% with a 2% coupon in 2016 to 3.17% with a 4.75% coupon in 2035; a 2040 split maturity was priced as 4 3/4s to yield 3.28% and as 5s to yield 3.23%; a 2045 term bond was priced as 5s to yield 3.29%.
The $48.165 million Series B non-AMT senior revenue bonds were priced to yield from 0/49% with a 3% coupon in 2017 to 2.88% with a 5% coupon in 2035; a 2040 term was priced as 5s to yield 2.92% and a 2045 term was priced as 5s to yield 2.97%
Both series are rated Aa3 by Moody's Investors Service and AA by Standard & Poor's and Fitch Ratings.
The $182.88 million Series C non-AMT subordinate refunding revenue bonds were priced to yield from 0.31% with a 2% coupon in 2016 to 2.96% with a 5% coupn in 2035; a 2038 term bond was prices as 5s to yield 3%.
The Series C bonds are rated A1 by Moody's and AA-minus by S&P and Fitch.
MSRB Reports Previous Session's Activity
The Municipal Securities Rulemaking Board reported 38,458 trades on Wednesday on volume of $13.490 billion. Most active on Wednesday, based on the number of trades, was the New Jersey State Transportation Trust Fund Authority Series AA transportation program 4 1/4s of 2044, which traded 103 times with an average price of 103.547 and an average yield of 3.796%.
