Munis play catch up on short end after Fed moves

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Most municipal benchmark yields were steady Monday, while ICE's muni curve saw short-end yields fall by 20 to 25 basis points following the Fed's move to add variable rate demand notes to its list of assets it would purchase.

Most market participants agreed the recent Fed decisions had munis playing catch-up.

The Fed added VRDNs to a list of assets eligible to be used as collateral by financial institutions, which contributed to some stability in the secondary market.

“The muni market starts the week stronger, with most of the strength evident from 10 years and in,” ICE said in a market statement. “This may partly be a reaction to the Fed’s announcement Friday to allow certain one-year and shorter munis to be used as collateral ... and it may also be a rebound from seemingly oversold conditions at the end of trading Friday. Muni-Treasury ratios are still extraordinarily high.”

“An hour-to-hour theme prevailed for several days, but Friday’s session found some balance following the Fed’s announcement to buy munis out to one-year maturities,” said Kim Olsan, senior vice president at FHN Financial in a market comment.

Monday saw similar moves, sources said.

“Dealers are not cutting prices as fast and as much as last week,” Michael Pietronico, chief executive officer at Miller Tabak Asset Management, said on Monday afternoon. At the same time, dealers were being more flexible to keep inventory moving, he said.

“The municipal bond market saw some buyers stick their heads up at these distressed levels, which has to be viewed as constructive,” Pietronico said.

“The sense we have is that participants now fully expect a lifeline from both the Federal Reserve, and Congress at some point,” he said. “In short, the market is attempting to form a bottom, however, should defaults begin to emerge another leg lower in prices cannot be ruled out.”

A New York trader said municipals are no longer tracking the Treasury market, but tracking the stock market, and traders like him are just looking at absolute yields for value.

“I am looking at where I can buy a bond where someone wants to sell it,” he said.

“There are a lot of casualties out there,” he said. “The financial crisis was a money thing, these are health issues.”

Routinely part of Lisa Shalett’s investment grade strategy, the chief investment officer at Morgan Stanley Wealth Management said munis were among the market’s most richly priced assets.

“Now, prices have fallen so much that the muni yields are their highest relative to comparable U.S. Treasuries in more than a decade,” she said. “While some concerns are about the creditworthiness of airports, hospitals and states/city governments at the epicenter of the COVID-19 crisis, there is also a lack of market liquidity.”

Olsan, though, noted a few places to point to market strength. Bonds due in the maturity range impacted by the new Fed action rallied 30 basis points or more—actively traded Texas Revenue Anticipation Notes due August 2020 tightened to 3%-range bid-sides from the prior day’s 3.30% or higher bidsides.“

Although the monetary action will be positive, it still leaves the very short end of the curve inverted as sellers are finding better liquidity from more willing buyers in ultra-short (i.e. very defensive) bonds,” she said. “Maturities of one to three years saw a 3% spike in volume last week as compared to the prior 30 days, according to MSRB data,” Olsan said.

Meanwhile, Moody’s said in a report released Monday that the coronavirus-driven market turmoil “is exposing municipal issuers to interest rate and liquidity risks related to outstanding short-term and variable rate debt.”

“The disruption comes as many issuers may need to raise cash to address sharp revenue declines and wide budget imbalances. Even borrowers with ample self-liquidity and ones with committed facilities from banks with strong balance sheets are experiencing the highest interest rates since the global financial crisis,” Moody’s said noting SIFMA's weekly reset rate on VRDBs climbed to 520 basis points on March 18, a 400-basis-point increase from the prior week.

There were others who said the Fed move hasn’t brought enough relief.

Brian Musielak, senior portfolio manager for Commerce Trust Co., said that there has been no material impact yet on the short term market from the Fed’s plan to help the muni market.

“Given this unprecedented move, we feel the market needs to see the program up and running before levels are impacted,” he said. “Including munis will go a long way to stabilizing the short end of the market which has gotten pummeled in the last week.

”The primary muni market has been at a standstill in terms of negotiated deals and Musielak noted that it’s hard for us to see sizable issues come to market until things stabilize. “Lack of market accessibility is certainly what the Fed is most concerned about and why they will likely include long term bonds in their quantitative easing program.”

Before this crisis, muni bond volume was on pace for yet another $400 billion plus year, so how much will this situation impact yearly issuance?

“No question there will be strong demand on the other side of this crisis,” Musielak said. “Not sure we can stabilize in time to recoup this calendar year.”

Other participants noted that private placements appear to be on the upswing as a result of current primary stagnation.

Secondary Markets
Munis were weaker on Monday on the MBIS benchmark scale, with yields rising nine basis points in the 10-year and by seven basis points in the 30-year maturity. High-grades were also weaker, with yields on MBIS' AAA scale increasing by 10 basis points in the 10-year maturity and by 12 basis points in the 30-year maturity.

Munis were steady on Refinitiv Municipal Market Data’s AAA benchmark scale, as the yield on both the 10-year and 30-year muni GO were unchanged from 2.79% and 3.37%, respectively.

BVAL saw the one-year unchanged as of publication, unchanged in the 10-year and one basis point cut in the 30-year.

The ICE muni curve was stronger by 11 basis points on the 10-year and four basis points on the 30-year maturity. But it was stronger by 25 to 20 basis points on the one- to four-year.

The 10-year muni-to-Treasury ratio was calculated at 268.4% while the 30-year muni-to-Treasury ratio stood at 197.8%, according to MMD.

Stocks were mostly in the red on Monday but pared back loses from early in the day and then sunk further later in the afternoon. Treasury yields were lower yet again.

The Dow Jones Industrial Average was down about 3.31%, the S&P 500 index was lower by 3.22% and the Nasdaq lost roughly 0.78% late in the session on Monday.

The three-month Treasury was yielding 0.025%, the Treasury two-year was yielding 0.294%, the five-year was yielding 0.394%, the 10-year was yielding 0.757% and the 30-year was yielding 1.342%.

Written by Lynne Funk, Aaron Weitzman, Christine Albano, and Chip Barnett.

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