A month after inclining to its steepest slope in decades, the municipal yield curve has flattened a bit.
Analysts and strategists say investors grew impatient with the paltry yields on short- and intermediate-term bonds. In the past month, this has prodded investors to become hungrier for yield and a bit less picky about maturity.
They have sold short- and intermediate-term munis, and bought long-term munis for their plumper yields.
The yield curve plots the relation of interest rates from short-term debt to long-term debt.
At the end of Jan. 30, yields on triple-A rated 30-year munis exceeded the yield on two-year munis by 382 basis points, according to Municipal Market Data. That was the widest spread since the early 1980s.
To put that into perspective, the average spread since the beginning of 1990 is 189.25 basis points, or less than half the spread at the end of January.
The steep yield curve expressed investors' preference for the shelter of short-term municipals and aversion to the credit, interest rate, and price risk of long-term munis. It also reflected the evaporation of arbitrage strategies that entailed buying long-term munis.
Since then, the slope has flattened a little. The spread of the 30-year over the two-year has declined 20 basis points.
The difference between 30-year yields over five-year yields is starker, compressing 57 basis points since the end of January.
While the yield curve is still steep by historical standards, the dynamic has shifted in the past month.
"We've had a steep yield curve do what it is supposed to do," said Philip Fischer, fixed-income strategist at Banc of America Securities-Merrill Lynch Research. "It has caused buying interest to move out from the short end of the curve to the long end of the curve."
In a report last week, George Friedlander, managing director and fixed-income strategist at Citi, said yields on short-term paper had become "painfully low."
Rampant buying of short- and intermediate-term munis by trust departments, investment counselors, separately managed accounts at fund families, and larger individual investors beginning in December pulled yields down to a level that made it hard to keep attracting buyers, he said.
"The large proportion of investors who had focused on that range had simply made yields in that range unappetizing," Friedlander said.
On Jan. 14, triple-A 10-years sported a yield of 2.82%, the lowest in almost three decades of data available at MMD.
Yields on other short-term, conservative investments like money market funds and short-term Treasuries were also extraordinarily low, Friedlander pointed out.
"Purchasing a three-year muni at a 2.5% yield isn't going to meet your retirement goals," said Guy LeBas, fixed-income strategist at Janney Montgomery Scott. "Retail investors, who are an increasing part of the market, need not just relative value but absolute return as well. ... The long end of the curve has proven to be a big retail interest because of the absolute level of yields on that side."
Fischer pointed to a total return of 3.06% for seven-to-12-year municipals since the end of last year, compared with a 7.98% total return for munis with maturities of 22 years or more.
Yields on all maturities have climbed in the sell-off of the past few weeks. However, long-term yields have jumped by 10 to 15 basis points less than the escalation in intermediate rates, Friedlander estimated.
A few other factors have brought long-term yields closer to short-term yields.
The Federal Reserve is committed to keeping interest rates low.
And the market's expectations for inflation are "very depressed," LeBas said.
Finally, President Obama's proposals to raise the top tax bracket to 39.6% from 35% would make investment income from munis more attractive relative to taxable investments.
