Wednesday’s market offered little, save for a fourth day of steady yields.
A trader in New York compared the muni market to a pack of wild horses nibbling the grass, pausing to look around, and then nibbling some more.
“This is a market that responds to herd instinct, but nobody knows which direction to run,” he said. “People are starting to think about the three-day holiday, and seeing if they can stretch it out to four or five days.”
Five-year note yields rose two basis points and 30-year bond yields fell one basis point, but all others were unchanged, according to Municipal Market Data’s triple-A scale.
A trader in San Francisco described the market as illiquid, while MMD analysts referred to trading as “lethargic.”
The four steady sessions follow a brief sell-off last Thursday, which slightly dented a five-week rally. MMD’s two-year scale held at 0.44% Wednesday, the 10-year note stayed at 2.65%, and the 30-year yield fell one basis point to 4.30%.
Meanwhile, The Bond Buyer’s one-year note index reached an all-time low of 0.38%. The index began July 21, 1989.
The benchmark 10-year Treasury yield finished at 3.13%, two basis points higher than Tuesday. The two-year yield rose three basis points to 0.535% and the 30-year yield rose two basis points to 4.27%.
Among a range of new mid-size deals Wednesday, Citi sold $278.2 million of school facility revenue bonds in two parts for the Eric County, N.Y., Industrial Development Agency. Both series carried low double-A ratings. The first series, worth $165.5 million, offered yields from 0.99% in 2013 to 4.83% in 2032. The second series, for $112.6 million, offered yields from 0.99% in 2013 to 4.14% in 2024.
Municipal analysts continue to see the past week more as a temporary pause in the rally rather than a reversal.
“Muni-to-Treasury ratios are on the low side of recent range, but we see continued room to run for munis given the dearth of new issues, and the strong reinvestment flows expected in June and July,” wrote Alan Schankel and Tom Kozlik, analysts at Janney Capital Markets.
“In June alone, about $50 billion of municipals will mature or be redeemed, dwarfing the $15 billion of average monthly new issuance through April,” they added.
The wealth management group at UBS released a monthly research note Wednesday arguing that muni prices should hold at current levels during the summer reinvestment period.
“We foresee demand outstripping supply for the remainder of the summer, lending technical support to the market through Labor Day,” according to the group headed by Thomas McLoughlin. “In light of the market rally, we suggest investors take this opportunity to upgrade the credit quality of portfolios, diversify holdings geographically, and consolidate odd-lot positions.”
Diversifying by region can mean giving up some tax-advantage, but with issuance down more than 50% nationwide and 70% to 90% in certain states, UBS analysts “strongly suggest crossing state lines more often,” as lighter issuance could mean better performance.
“Investors should be prepared for technical factors to weaken after Labor Day,” the analysts wrote, citing the potential for a Treasury sell-off combined with some supply returning to the muni market.
“Offsetting factors that could keep municipal yields lower for longer include: a structural shift to a prolonged period of lower issuance and Treasury rates not rising significantly,” they added.
McLoughlin’s team noted that 2011 issuance is likely to come in below the $225 billion mark, the slimmest amount since 2000. Other forecasts tend to range from just under $200 billion to $240 billion.
With banks continually revising their estimates lower, it was only a matter of time before rating agencies gave their two cents. Standard & Poor’s and Moody’s Investors Service released reports Wednesday citing a number of factors that will lead to less issuance this year and next.
“While we typically see debt levels increase during times of fiscal difficulty, we wouldn’t be surprised to see a weaker debt issuance trend in 2011 and 2012 given our view of the state of the market and the fiscal and political environment,” Standard & Poor’s wrote.
The Build America Bond program, which provided a 35% interest payment subsidy on taxable issuance for state and local governments until its expiration on Dec. 31, 2010, played a huge role in last year’s record volume as issuers front-loaded bond sales into 2010 to capitalize on the program.
Issuers also anticipated additional investor appetite for munis following the expected termination of the Bush tax cuts at the end of 2010, Moody’s wrote.
Total debt issuance for state and local governments was $48.3 billion in the first quarter of 2011, compared with $133.4 billion in the last quarter of 2010. And fiscal 2011 first-quarter issuance was down 46% compared with 2010 first-quarter issuance of $103.1 billion.
“While most states continue to experience budgetary strain, they appear to be avoiding deficit financings or bond issuances for debt restructuring to balance budgets,” Moody’s said in its report. “Most states will likely turn to revenue increases, through taxes and fees, and spending cuts to resolve their budget gaps.”
But states will continue to use long-term debt to finance their capital needs, as they will have fewer options to fund projects through weak revenue growth and continued budget reductions. Higher capital costs will mean lower overall issuance for states’ capital needs this year, Moody’s said.
Some states have already reduced their capital budgets for fiscal 2012, compared with past years and previous issuance projections, Standard & Poor’s said.
