The municipal bond market is in a standoff.
Having undergone a crazy, screaming rally late in the summer and a sharp sell-off in the early fall, the municipal market hardly budged last week.
The yield on the 10-year triple-A municipal bond strengthened two basis points to 3.01% Friday, according to the Municipal Market Data scale. That leaves it pretty much where it was three weeks ago.
The Municipal Market Advisors scale also showed the 10-year strengthening a basis point to 3.17%, unchanged for the month.
“We’re just in a standstill,” said a trader in Chicago.
The flat trading over the past few days poses important questions: is the market still recoiling from a peak last month that most analysts said ignored fundamentals? Or has the market corrected?
When the yield on the triple-A 10-year collapsed 30 basis points in 30 days in late September and early October to about 2.5%, most analysts attributed the rally to a supply-demand imbalance rather than to anything inherent in municipals.
Mutual funds were armed with nearly $70 billion of new money from investors this year at the same time issuance of new tax-exempt bonds was down 12% for 2009. The result was too much cash chasing a scarce product.
Thomson Reuters analyst Michael Bouscaren at the time cautioned investors to respect the power of this imbalance, even if it made no fundamental sense.
Now that the market has rebalanced, Bouscaren said people are once again able to consider fundamental factors without worrying that the imbalance of cash and supply will overwhelm them.
As a result, multiple factors arguing for higher and lower yields are competing.
Arguing for higher yields are concerns about shrinking local tax receipts and bad municipal credit, Bouscaren said. Allstate Corp. offered a good illustration of this last week, when the Northbrook, Ill.-based insurer said it shed $2 billion from its investment portfolio in the third quarter because of reservations about credit quality.
Arguing for lower rates are the Federal Reserve’s express commitment to tether its interest rate targets to zero, an unemployment rate north of 10%, and the prospect that U.S. government programs will render tax-exempt bonds a “collector’s item,” Bouscaren said.
So nebulous is the true value of municipals that some traders disputed how accurate the strength reflected by the MMD scale was.
One trader in New Jersey said the notion that yields have been unchanged the past few trading days is “ludicrous.” Yields are decidedly still spiking up and it is hard to induce people to buy bonds, the trader said, offering the Pennsylvania Turnpike as an example of a name he has seen run into trouble finding bids.
“The bid side stinks,” he said. “It’s weaker than it appears.” The trader said municipals earlier in the day were weaker by a couple of basis points.
Municipal bond exchange-traded funds lend support to the trader’s argument that municipals are weaker, in spite of the lower yields in the MMD scale. The biggest municipal exchange-traded fund, the iShares S&P National Municipal Bond Fund, is theoretically a second-by-second proxy for the Standard & Poor’s AMT-Free National Municipal Bond Index. The $1.53 billion fund slipped three cents Friday, to $102.16. The shares fell each of the previous three days, while the MMD scale was unchanged.
The fund, which soared while the muni market was rallying, is down 3% since the municipal market peaked on Oct. 5.
Another trader in New Jersey said many dealers and traders are worried a big new deal could disrupt liquidity in the market if the underwriters don’t find buyers quickly. Traders in the secondary market are reluctant to stockpile bonds in their inventories because they don’t want to be stuck with them if a rush of new debt hits the Street from a poorly subscribed deal, he said.
“Traders have been risk-averse,” the trader said. “I’m not seeing a lot of guys out there really wanting to take a lot of risk.” He said he does not think the sell-off is over, even if yields Friday may have been unchanged or lower.
