Municipals surged to match record-high prices yesterday as many traders doubted whether the latest wave of new bonds can satiate a market still starved for paper.
The yield on the 10-year triple-A municipal bond ticked down a basis point yesterday to close at 2.78%, according to the Municipal Market Data scale, which matches the lowest yield since MMD began keeping track in the early 1980s.
The 30-year triple-A also shaved a basis point to close at 4.1%, though this is still about 20 basis points off the record.
Municipal bonds have been on a practically unbroken winning streak for more than a month. The Barclays Capital index tracking returns on long-term municipal bonds is up 6% since the beginning of August.
Yesterday, many of the biggest vehicles for trading municipal bonds ascended to new apexes.
Most traders and analysts attribute the rally to a spike in demand coupled with a paucity of supply. Demand has been bolstered by the prospect of higher taxes and almost $54 billion in investments in muni bond mutual funds this year.
Supply has been eviscerated by the unavailability of letters of credit for variable-rate debt obligations, as well as the transference of bond sales from the tax-exempt market to the taxable market through the Build America Bonds program. Issuance of tax-exempt paper is down 17.7% for the year as of the end of August, according to Thomson Reuters.The result: too much cash chasing not enough product.
"It's a food fight," a trader in Florida said. "Buyers are coming out of the woodwork. Funds are looking to buy anything and everything that isn't nailed down."
In his daily commentary, Thomson Reuters analyst Randy Smolik said spreads continue to collapse as investors stretch for better returns in light of the sickly yields on top-notch paper.
Smolik noted two illustrative competitive sales: the $400 million Illinois general obligation deal and the $300 million Port Authority of New York and New Jersey offering.
The Illinois bonds - rated A1 by Moody's Investors Service and AA-minus by Standard & Poor's - priced at spreads over the MMD scale of between 40 and 60 basis points, depending on the maturity, while the Port Authority deal - rated Aa3 by Moody's and AA-minus by Standard & Poor's - priced at just 10 basis points over the MMD scale.
Smolik called the spreads "impressive."
Indeed, as ferocious as the rally overall has been, it has been more pronounced farther down the credit ladder. While the 10-year triple-A yield has shed 22 basis points in the last month, the single-A has dumped 55.
Many in the market doubt the fundamental undergirding of this rally, and attribute it to momentum and "technical" - meaning artificial and possibly ephemeral - factors.
Some market sources have said a flurry of new supply is the most likely threat to this rally. When asked what it would take to derail this hot streak, a trader in Los Angeles said: "More supply than we have right now."
A trader in New York said this week marks the first real test of the potential fragility of the rally's underpinnings, as $9.11 billion in new bonds were slated to come to market as of the beginning of the week.
Overwhelming demand has propelled bond prices too high, this trader said, leaving yields "very unattractive." He said everyone is waiting to see whether the new supply dents demand. Even though many people think yields are too low, the sheer volume of cash in the market has forced money managers to snap up whatever scarce bonds were available, the trader said.
"Now you address that situation with some primary market supply and you find out whether these levels are unsustainable," he said. "I think the jury's out at the moment. ... The market could be vulnerable based on the low level of yields."
The trader in Los Angeles said he did not think the newest round of supply would be enough to sate the ravenous market.
The 30-day visible supply, which measures bonds scheduled to be sold in the next month, swelled to $12 billion at the end of last week, after spending three weeks under $10 billion. The rampant buying in municipals has funneled to the vehicles used to gain exposure to the asset class.
The biggest muni exchange-traded fund - iShares Standard & Poor's National Municipal Bond Fund - yesterday registered its highest price since launching in September 2007. The second-biggest muni ETF - SPDR Barclays Capital Municipal Bond Fund - missed its all-time high by a penny.
The biggest municipal bond mutual fund, Vanguard Intermediate-Term Tax-Exempt Admiral Shares, yesterday reported its richest net-asset value since January of last year. The second- and third-biggest municipal mutual funds also reported their highest asset values for 2009.
Some of the biggest municipal closed-end funds reached near-term zeniths as well. The BlackRock MuniYield Insured Fund, the Nuveen Premium Income Municipal Fund, and the Nuveen Performance Plus Municipal Fund Inc. - respectively the third-, fourth-, and fifth-biggest muni closed-end funds - all hit their highest prices in more than a year.