The municipal market languished Tuesday as traders remained reluctant to place bets with a hefty batch of new supply looming over the market.
Municipal bonds weakened two basis points for maturities longer than 12 years, according to the Municipal Market Data curve, with the 30-year yield ticking up to 3.88%. Munis were unchanged for maturities 10 years and in, based on the MMD scale.
Traders seem increasingly skittish about an impending surfeit of new state and local government debt. Municipalities are scheduled to sell $13.6 billion of bonds over the next 30 days, based on The Bond Buyer’s visible supply.
The market sold off about 10 or 12 basis points last week as it had trouble digesting $9.8 billion of new debt. Municipal bonds delivered a return of negative 0.4% last week, according to the S&P/Investortools Municipal Bond Index. According to Bloomberg LP, dealers were seeking bids for $866.7 million of bonds on Monday, the biggest bid-wanted list since January.
“From a seasonal point of view, we’re vulnerable to supply,” a trader in New York said. “It could be a continued imbalance between what’s coming, and the market’s ability to absorb it.”
Nearly 30% of municipal borrowing last year was floated in the fourth quarter, according to Thomson Reuters.
In this year’s fourth quarter, the market enters a seasonally heavy period for issuance just as the demand side is losing some of its buoyancy. Municipal bond mutual funds have gone eight straight weeks without a $1 billion weekly inflow from investors — a figure that was standard for most of 2009 and early 2010.
“There is tremendous supply pressure, and there will be between now and yearend,” said Duane McCalister, who manages the $447.3 million Marshall Intermediate Tax-Free Fund. “This is kind of a tougher seasonal period for munis right now. … That supply pressure will probably put a little additional pressure on credit spreads.”
McCalister welcomes a back-up in spreads, which would give him an opportunity to pick up bonds at cheaper prices.
Yields are still only about 35 basis points off the all-time lows touched in late August — a record reached at a time of meager tax-exempt supply.
McCalister said he is holding “a little excess cash” to take advantage of the wider spreads, if they come.
Thomson Reuters analyst Randy Smolik wrote in his daily commentary that traders aren’t just worried about the calendar. Today’s elections carry critical implications for the supply of long-term tax-exempt bonds.
If Republicans assume control of the House, some people think it might be tougher to pass an extension of Build America Bonds, which have siphoned significant supply from the tax-exempt market to the taxable market. Municipal governments have floated $153.7 billion of BABs since the program launched in April last year, most of it long-term bonds.
Market experts believe that, without the BAB program, most of that sum would have been pushed through the tax-exempt market, which has long had trouble finding buyers for long-term paper. Nearly 25% of municipal borrowing this year has been through BABs.
“Reduced likelihood of BAB passage may translate into weakness among long-term bonds because that would increase tax-exempt issuance in 2011 as BAB issuers turn to tax-exempts,” LPL Financial Research fixed-income strategist Anthony Valeri wrote in a report Tuesday.
Smolik said he has already seen problems as investors rethink what the sunset of the BAB program would mean for supply on the long end of the tax-exempt yield curve. He pointed to New York City general obligation bonds maturing in 13 years trading at a spread of 58 basis points over triple-A rated municipal bonds, up from recent trading at spreads in the low 50s.
He also noted Stanford University’s 30-year bonds changing hands at a spread of 19 basis points, the highest in a few months. A handful of other names are “appearing on the concession side,” he said.
“Given that 25% of issuance this year has been BABs and that this program has mainly siphoned off tax-exempt issuance beyond the 10-12 year range, no BABs would have to mean primary supply pressures out long starting in 2011,” Smolik wrote.
Investors exhibited some hesitation yesterday over absorbing newly issued bonds with maturities of more than 10 years, he said.
In a negotiated deal underwritten by Morgan Stanley, the Ohio Turnpike Commission priced its $131.3 million of revenue refunding bonds with the longest maturity in 2031 at a yield of 4.25% — which Smolik said was 10 basis points higher than initial indications a day earlier.
The anxiety at the long end of the tax-exempt curve ignored a strong day for long-term Treasuries. The 30-year Treasury rallied eight basis points, while the 10-year strengthened four.
As the overall bond market prices in expectations for quantitative easing, municipal yields relative to Treasuries are elevated, extremely so at the front end of the curve.
Under its first QE program, the Federal Reserve concentrated its purchases of Treasury bonds in the two-to-10-year maturity range. With investors expecting the Fed to double down on that effort, Treasury yields at that portion of the curve have come down. As a result, the two-year tax-exempt triple-A yield is 135% of the Treasury yield, and the five-year tax-exempt yield is higher than the five-year Treasury — both well above their historical averages.
Also in the primary market, the Massachusetts Development Finance Agency priced $195.3 million of revenue bonds secured by a loan to Boston College.
Underwritten by Barclays Capital, the negotiated deal comes in two series. The first will feature maturities from one to 30 years, and yields respectively from 0.32% to 4.3%. The second series will mature from 2011 through 2031, with yields ranging respectively from 0.32% to 4.08%.
In the competitive market, Bank of America Merrill Lynch won the bid for the Florida State Board of Education’s $173.9 million deal. Maturities run from 2013 to 2022, with a yield at the longest maturity of 3.5%. The board is rated AAA by Standard & Poor’s, A-plus by Fitch Ratings, and A1 by Moody’s Investors Service.
