Call it a case of self-induced volatility.
Muni yields plummeted in the wake of the Federal Reserve’s Sept. 21 monetary policy meeting, prodding issuers to tap the capital markets. With back-to-back weeks of $8 billion in new supply, rates are now jumping back up.
The Bond Buyer’s 20-bond general obligation index of 20-year GO yields climbed 21 basis points this week to a five-week high of 4.14%, marking a second week of rocketing yields. Just two weeks ago, the index was at 3.85%.
The 11-bond GO index of higher-grade 20-year GOs also climbed 21 basis points, to a nine-week high of 3.88%. A week earlier, it rose nine basis points, whereas in mid-August it bottomed out at a 43-year low of 3.55%.
The Bond Buyer’s revenue bond index, which measures 30-year revenue bond yields, moved three basis points up to a three-week high of 5.04%.
Tim Pynchon, senior vice president and lead portfolio manager at Pioneer Investments, said the tax-free market finds itself in a conundrum.
“Two weeks ago, it looked as though munis were going to catch fire from a demand standpoint,” he said. “The seemingly inevitable implosion that Europe is heading towards” caused equities to gyrate and had fearful investors fleeing the corporate market, particularly the high-yield sector.
“Then we had Operation Twist take effect and Treasury rates were dropping, dropping, dropping,” Pynchon added, referencing the Fed’s decision to buy long-term bonds and flatten the yield curve. “At first we saw a slight muni rally, but then new supply hit, spreads suddenly widened, and that’s exacerbated muni-Treasury ratios.”
Muni-Treasury ratios for the 10-year and 30-year spots each jumped beyond 128% this week.
The conundrum is that with munis this cheap relative to Treasuries, crossover buyers typically jump into the market and push tax-free yields back down. But such buyers are cash-strapped at the moment, so there’s no natural cap to rising ratios.
“There’s not enough cash on the sidelines to exploit that cheapness,” Pynchon said. “So we’re going through a period of adjustment now that may take a few days or a few weeks to settle.”
Treasuries, often the guiding force for tax-free yields, were little more than background noise this week.
The 10-year Treasury fluctuated from 1.72% to 2.07% over the five sessions but finished Thursday at 1.99%, up a basis point from the previous week.
The 30-year Treasury bond was even more in flux. Beginning last Friday at 3.03%, it rallied to 2.70% on Tuesday morning, then shifted gears as the stock market recovered and closed Thursday at 2.96%.
The clear underperformance of munis may have caught some issuers by surprise.
Morgan Stanley had to reprice longer-term yields by as much as nine basis points between the retail and institutional pricings for the $608 million revenue deal from New York’s Triborough Bridge and Tunnel Authority.
Despite such concessions, it remains an excellent time for issuers to borrow. The 2011 average for the 20-year GO index is 4.64% — half a percentage point higher than the current level.
“This has been an extraordinary low-interest rate environment for issuers,” Pynchon said. “The conundrum is that issuers aren’t looking to borrow; they are looking to cut.”
Meantime, the weekly average yield to maturity on The Bond Buyer’s 40-bond muni index, which is based on prices for 40 long-term muni issues, moved up two basis points to 4.92%.
Finally, the one-year note index fell four basis points to 0.29%, reversing the previous week’s four basis point climb.