The tax-exempt market continued a second session of losses Monday as yields were steady to two basis points higher.
Traders noted that while munis ended weaker, the market is not in panic mode, and could see some firming later in the week once August 1 reinvestment money floods the market.
"It feels like the tone of the market says we gave up about a basis point or so," a Chicago trader said. "We did see losses on Friday with good news from Europe so it's good we have lower supply now to match off with continued strong August reinvestment money. That should be a consistent theme."
Indeed, other traders agreed. "Everyone was expecting the market to be weaker given what happened Friday in Treasuries," a trader located in the Southwest region said. "But, syndicates are firm and they are better than other pricings. It's slow from a retail standpoint, but there is still business going on. There is August 1 money coming in and supply is not overwhelming so no one is going to panic here."
Munis ended weaker for the second consecutive session, according to the Municipal Market Data scale. Yields inside six years were steady while the seven- to 14-year yields increased between one and two basis points. Outside 15 years, yields were flat.
The 10-year MMD tax-exempt yield jumped two basis points to 1.66%, hovering above its record low of 1.60% set Thursday. The 30-year muni yield finished flat at 2.84%, five basis points above its record low of 2.79% set Wednesday. The two-year was steady at 0.29% for the consecutive session.
Treasuries continued to strengthen across the curve. The benchmark 10-year yield dropped five basis points to 1.50% while the 30-year yield plunged six basis points to 2.57%. The two-year yield fell three basis points to 0.23%.
In the secondary market, trades compiled by data provider Markit showed weakening. Yields on Ohio 5s of 2020 jumped six basis points to 1.73% while Houston 5s of 2018 rose five basis points to 1.13%.
Yields on New York City Transitional Finance Authority 5s of 2023 rose four basis points to 2.38% while Atlanta Water and Wastewater System 5.25s of 2034 increased three basis points to 3.16%.
So far in July, muni to Treasury ratios have fallen as munis outperformed their taxable counterparts and became comparatively more expensive. The five-year muni yield to Treasury yield ratio fell to 104.8% on Monday from 116.4% on July 2. The 10-year ratio dropped to 110.7% from 117.1% at the beginning of July. The 30-year ratio fell to 110.5% on Monday from 117.5% at the start of the month.
Despite weakening over the past two sessions, the slope of the yield curve has flattened over the course of July as demand has outweighed supply. The one- to 30-year slope of the curve flattened to 265 basis points on Monday from 296 basis points on July 2. The one- to 10-year slope of the curve flattened to 147 basis points from 165 basis points at the beginning of the month.
Credit spreads compressed throughout the month on the short and long end but widened in the intermediate part of the curve. The five-year triple-A to single-A spread compressed to 61 basis points on Monday from 66 basis points on July 2. The 30-year spread compressed to 73 basis points from 80 basis points at the beginning of the month.
The 10-year triple-A to single-A spread widened throughout the month as supply outweighed demand and investors moved to other parts of the curve. The 10-year spread widened to 83 basis points from 79 basis points at the start of the month.
Muni exchange-traded funds have seen positive returns so far in July, but have had mixed results against Treasuries and corporate counterparts. The iShares S&P National AMT-Free Municipal Bond ETF — ticker MUB — rose 1.53%. The SPDR Nuveen Barclays Capital Short Term Municipal Bond ETF — ticker SHM — increased 0.16%. The PowerShares Insured National Muni Bond ETF — ticker PZA — rose 2.02%.
Muni ETFs underperformed the ProShares Ultra Seven to 10 Year Treasury ETF — ticker UST — which rose 2.06% so far in July.
Muni ETFs came in mixed compared to corporate bond ETFs. The iShares iBoxx High Yield Corporate Bond ETF — ticker HYG — rose only 0.57% so far this month, but the iShares IBoxx Investment Grade Corporate Bond Fund ETF — ticker LQD — jumped 2.52%.
And while munis weakened Monday, most analysts think tax-exempts will generally perform well through the summer until a drop off in reinvestment money in the fall. "Although supply is higher year-over-year by 65%, the majority of issuance has been for refunding purposes and does not add to net supply," wrote John Dillon, chief municipal bond strategist at Morgan Stanley Smith Barney. "With favorable municipal market technical expected to remain in place through the summer, we reiterate our constructively neutral stance."
Dillon added that while muni yields are at or near record lows, munis still look attractive relative to Treasuries. Those two factors combined will keep any major price movements in check. "The counterbalances of record-low yields and elevated municipal relative value ratios lead us to believe that any muni-specific price activity will be muted until September when favorable seasonals being to fade."
With recent announcements of bankruptcies or bankruptcy filings, Dillon advocates keeping fairly high credit quality. "Credit quality parameters should not be relaxed at this time," he said. "We continue to advocate six- to 14-year maturities via a blend of high-quality mid-tier A-rated or higher essential service revenue and general obligation bonds. State level GO and appropriated paper also appear compelling given generally improving credit quality."
He continued that while he is constructive on state level GO bonds, he is more cautious with local level bonds as those revenue drivers differ from the state level. "Although this dynamic is not news to anyone in the municipal bond business, it remains the basis for our continuing expectation of a slow burn for local credit quality and the accompanying credit rating downgrades."