Munis Gone Wild Session Leaves Traders Dizzy

The municipal bond market easily outperformed the Treasury market Wednesday as institutional investors recognized that relative valuations were at some of the most attractive levels all year.

Changes in the Municipal Market Data triple-A curve were staggering as buying pressure on the long end brought down yields a dizzying 14 basis points to fresh 2011 lows.

“My head is spinning,” said a retail trader in New Jersey. “It’s just wacky out there. So much is going down in Treasuries — it’s hard to compete with those kind of moves.”

All spots on the MMD curve beyond 2021 fell at least 10 basis points, creating the lowest yield environment ever in the post-Build America Bonds era.

“The action has finally kicked into the muni market,” an institutional trader in Los Angeles chimed in, referring to last week’s underperformance as muni traders sat on their hands despite a broader flight to safe havens. “Yesterday we were crazy — which is always wonderful — and today it seems like the market is never going to stop.”

“Participation from fast money players was especially noticeable in the high-grade sector,” said MMD analyst Domenic Vonella, noting that certain triple-A to triple-B blocks “were trading at spreads inconsistent with where traditional muni players have purchased similar credits historically.”

The moves were so quick, retail investors could hardly react.

“This is a month that’s traditionally light in trading, in a year that’s been extremely light in volume, so this isn’t going to make life easy for us,” the New Jersey trader added. “It’s going to be a struggle. I know a lot of guys are involved simply because they feel they need to be, but the Street is relatively quiet. It’s not like I’m seeing huge retail participation. There is wide resistance to these levels.”

The Los Angeles trader predicted the retail market would have a hard time catching up with the new reality.

“Yields are so low,” she said. “But whether they want to ignore or fight it, they can’t. This is all you get.”

The benchmark 10-year muni yield finished Wednesday at 2.45%, its lowest yield since late October. Its yield has now dropped 18 basis points since Monday, and a look at muni-Treasury ratios indicates there could be plenty of room to keep falling: the 10-year ratio ended at 94.2% Wednesday, versus a 2011 mean of 90.4% and a long-term average of 84%.

“We’ll see if this gets our retail clients off the sidelines, but today that’s where they were,” the New Jersey trader said.

The 30-year muni yield ended at 4.05%, its lowest since early November. Its yield has dropped 25 basis points since Thursday, but the 30-year muni-Treasury ratio is still an attractive 104.4%. The average 30-year ratio in 2011 is 103.7%.

The two-year muni yield fell another two basis points to 0.36%, its lowest yield since Sept. 1, 2010. Still, the two-year muni-Treasury ratio was 109%, giving plenty of room to outperform given that its 2011 mean is 100%.

It’s hard to say if low yields can be sustained but they probably will, the L.A. trader added. After all, the muni market faced record low yields in August 2010.

Munis outperformed Treasuries on the day but only because tax-exempts lagged the earlier flight to quality.

“Munis are up, but they’re not nearly up as much as Treasuries were this week,” the New Jersey trader said. “We are playing catch up here, there’s no question.”

The 10-year Treasury yield fell just under 2.55% in mid-morning but ended flat at a nine-month low of 2.61%. In mid-April it yielded at much as 3.59%, or 99 basis points more than on Wednesday.

The 30-year yield, after dropping an incredible 19 basis points Tuesday, fell another two basis points to 3.89%.

With investors flocking to intermediate and long bonds, the two-year Treasury yield actually rose a basis point to 0.33%.

A trader in Dallas said the threat of a downgrade to hundreds of muni credits linked to the sovereign credit has now passed, so “we’re back to the low-supply issue.”

The market is expected to only absorb $3.25 billion in new supply this week after issuers decided to play it safe and avoid borrowing during a volatile period.

Bad move, it turns out. Issuers lucky or smart enough to be in the market are getting one heck of a deal.

Major offerings included the New York City Transitional Finance Authority, which sold $448.3 million of tax-secured subordinate bonds. The TFA deal is rated Aa1 by Moody’s Investors Service and AAA by Standard & Poor’s and Fitch Ratings.

Yields ranged from 0.43% on a 2% coupon in 2013 to 3.87% on a 5% coupon maturing in 2029. In Tuesday’s retail period, 2029 bonds with a 4% coupon were sold at par.

Triple-A rated Montgomery County, Md., sold $320 million of GO bonds in the competitive market. JPMorgan won the issue at a true interest cost of 3.23%. Yields ranged from 0.54% in 2014 to 4% in 2031. Citi won a separate deal for $212.1 million of Montgomery GOs.

Primary market issuance “helped to solidify the muni bond rally,” Vonella said.

“A lot of L.A. GOs that came from JPMorgan are finally getting put away,” added the Los Angeles trader, referring to a July 22 competitive deal that other traders have called mispriced.

Among high-yield offerings, San Buenaventura, Calif., priced $350 million of revenue bonds for Community Memorial Health System. Underwritten by Bank of America Merrill Lynch and rated Ba2 and BB by Moody’s and Standard & Poor’s, the bonds offered yields from 5.11% in 2016 to 7.65% in 2041.

“That deal should get put away today, no problem,” the Los Angeles trader said. “Merrill should have nothing on their books by the end of the day; if they do I’ll be shocked.”

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