On tenterhooks ahead of $10B slate, market warily eyes world events
Uncertainty is the keyword this week as a confluence of events — a widening war in the Middle East, oil price volatility, and a Federal Reserve meeting taking place under presidential pressure — will shape how the municipal bond market will greet over $10 billion in new supply.
Monday’s market arrived with a firming Treasury market feeling the impact from the drone attacks on Saudi Arabia, however that didn't translate to munis.
“The muni market is a lot different than Friday — and it has definitely been shaken quite a bit by the complete change in rates,” a New York trade said on Monday afternoon. “Munis have not tracked the Treasury firmness at all — and is slightly weaker today.”
In the Middle East, Houthi rebels took responsibility for a drone attack on Saudi Arabia’s oil infrastructure that may temporarily cut Saudi Arabia’s oil output in half. The rebels are based in Yemen, but backed by Iran.
“Clearly this is not Houthi technology. This attack is an extension of the proxy war in Yemen, but quite sophisticated unlike past Houthi attacks. Just like Iranian Quds Force and Hezbollah IED proliferation, this is a new tool we should expect to see flourish,” Frank Kearney, a member of Academy Securities Geopolitical Intelligence Group and a retired U.S. Army lieutenant general, said in a Monday report. “Not surprising to see the attack focused on Saudi oil infrastructure as it targets the heart of the Kingdom’s economic power. It is very hard to defend against this type of attack. We can expect to see retaliation and escalation between the involved parties.”
James "Spider" Marks, Academy Securities head of geopolitical strategy and senior advisory board member, placed the blame squarely on Iran’s shoulders.
“Tehran is responsible for this attack. We see Iranian influence and its aggressive policies continuing. I would expect retaliatory strikes by the Saudi Air Force and the Israel Defense Force will take advantage of the regional chaos and strike into Syria,” said Marks, a retired U.S. Army major general. “Despite a challenged history, at this moment, and especially against Tehran, Riyadh and Jerusalem are ‘partners.’ For Iran’s response, watch the Strait of Hormuz. Iran will declare innocence with regard to the drone strikes and will claim its increased provocation is defensive.”
Academy Securities Geopolitical Intelligence Group said that the price of oil would rise, with Brent Crude rising faster than West Texas Intermediate.
“This fits with our ongoing theme that securing ‘safe’ energy sources should be paramount to many companies’ strategies and supports our ongoing National Defense efforts for full domestic energy self-sufficiency,” the group said.
They added that while an attack of this magnitude would traditionally create a risk off moment, they didn’t think that would be the case right now.
“As a net exporter, we have exhibited great resilience to disturbances in the Middle East. In fact, the argument could be made, and we’ve made it repeatedly, that higher energy prices, especially when the result of supply disruptions in the Middle East or elsewhere are very good for the U.S. economy and energy companies,” the group said in a statement. “It will also ensure D.C. remains focused on the issue of domestic supply and continues to support, rather than antagonize, that industry. So, energy equities and bonds may continue to see a bounce in prices that started in late August and accelerated last week.”
On the Treasury and rates side of the equation, the report said the usual reaction would be a flight to safety bid, but that may not be the case now.
“We may see that as a knee-jerk reaction, but unless there are clear signs of significant escalation, rather than 'just' retaliation, we think the rally in Treasuries will be short-lived. In fact, this only adds to the inflationary pressures we have seen creeping into the market with some recent data.”
And in Washington, D.C., this week the Federal Open Market Committee meets to decide the course of interest rates. And President Donald Trump kept up the pressure on the Fed.
“The United States, because of the Federal Reserve, is paying a MUCH higher Interest Rate than other competing countries. They can’t believe how lucky they are that Jay Powell & the Fed don’t have a clue. And now, on top of it all, the Oil hit. Big Interest Rate Drop, Stimulus!,” Trump tweeted on Monday.
A 25 basis point cut in the fed funds rate is widely expected, but the market's eyes will be on the Summary of Economic Projections, know as the dot plot.
“We see the dot plot as a centerpiece" of the FOMC's "formal communication of an easing bias, albeit one with a path that remains substantially shallower than market pricing,” according to a note from BNP Paribas’ economics team, led by Daniel Ahn, chief U.S. economist. Fed Chair Jerome “Powell will have the challenge of squaring the two at the press conference.”
The panel will cut rates by “a further 100 basis points through June 2020, as an expected downturn in growth over the next several quarters compels it to ease policy beyond precautionary considerations,” the note said.
Brian Rehling, co-head of global fixed income strategy for Wells Fargo Investment Institute noted despite “a big divergence of opinions on the Fed” panel, “the governors are all still aligned to Powell” and will vote for a rate cut at this meeting.
“The market has discounted a 25 basis point cut at the Fed’s Sept. 18 meeting and it appears likely that the FOMC will deliver,” said Gary Pzegeo, head of fixed income at CIBC Private Wealth Management. “There is a small chance that the Fed could lower the target rate by 50 bps, but movement at the margin toward a trade deal between the U.S. and China could lead to a repeat of the July 31 ‘insurance’ cut.”
Bond supply this week is expected to hit $10.3 billion in a calendar composed of $8.3 billion of negotiated deals and $1.99 billion of competitive sales.
“The primary calendar for the coming week totals about $10 billion, with an atypical 24% of the total comprised of taxable deals. Through August, taxable offerings accounted for more than 10% of muni bond issuance, the highest share in six years,” Janney said in a Monday market comment. “A key reason for the increase in taxable issuance emanates from the December 2017 Tax Cuts and Jobs Act, which ended the use of tax-free bonds to advance refund outstanding debt. With the differential between taxable and tax-free yields relatively narrow, issuers are increasingly shifting to taxable issues to advance refund outstanding debt.”
Janney took this week’s $965 million taxable refunding deal by the Bay Area Toll Authority, California (Aa3/AA/AA) as an example.
“The issue will pre-refund 2012 and 2014 issues, escrowing the bonds to the respective 2022 and 2024 first redemption dates, locking in near record low rates. The issuer would otherwise be required to wait until 2022 and 2024, respectively, if the refunding was to be accomplished with tax free bonds, with the risk that interest rates will be higher, potentially limiting or eliminating the amount of interest savings achievable via refinancing.”
Action kicked off on Monday as the Gwinnett County Water and Sewerage Authority, Georgia (Aaa/AAA/AAA) competitively sold $132.84 million of Series 2019 revenue refunding bonds.
JPMorgan Securities won the issue. PFM Financial Advisors was the financial advisor; Kutak Rock was the bond counsel. Proceeds will be used to current refund certain outstanding debt.
Monday’s bond sales
BofA sees 2020 issuance at $400B
Issuance so far this year has totaled about $254 billion, with $169.3 billion of new money and $84.4 billion of refunding bonds, on track to meet or exceed BofA Securities target of $365 billion, the firm said in a weekly market comment.
“But in the mix of new money and refunding are different than we originally estimated. New-money volume is likely come in at $250 to $255 billion by the year end, less than our original target of $270 billion, but refunding volume should exceed our $95 billion by a large amount, and reach $115 to $120 billion,” Yingchen Li and Ian Rogow, BofA Research Strategists, said in the report.
“Looking forward to 2020, our preliminary target would be a total of $400 billion, with $270 billion in new money and $130 billion in refunding. New money growth reflects our low rates view, GDP growth and population growth for the past few years,” they said. “Refundings reflect the pool of available bonds eligible for current/forward refunding and possible new techniques of using taxable or other means in advance refunding. The pool of callable bonds for 2020 currently stands between $175 and $180 billion, only slightly lower than the pool level for 2019.”
BofA estimates that redemptions for 2020 are estimated to be about $249 billion and coupon payments at $132 billion, adding up to $381 billion.
Last week's actively traded issues
Revenue bonds made up 52.50% of total new issuance in the week ended Sept. 13, up from 52.22% in the prior week, according to IHS Markit. General obligation bonds were 42.54%, down from 43.11%, while taxable bonds accounted for 4.96%, up from 4.67%.
Some of the most actively traded munis by type were from California, Texas and New Jersey issuers.
In the GO bond sector, California 3s of 2020 traded 72 times. In the revenue bond sector, the Texas TRAN 4s of 2020 traded 35 times. In the taxable bond sector, the Rutgers University 3.915s of 2019 traded 61 times.
Munis were mixed on the MBIS benchmark scale, with yields rising by six basis points in the 10-year maturity while falling less than a basis point in the 30-year maturity. High-grades were weaker, with MBIS’ AAA scale showing yields rising by four basis points in the 10-year maturity and by two basis points in the 30-year maturity.
On Refinitiv Municipal Market Data’s AAA benchmark scale, the yield on the 10-year muni GO rose by three basis points to 1.55% while the 30-year muni rose three basis points to 2.16%.
The 10-year muni-to-Treasury ratio was calculated at 84.1% while the 30-year muni-to-Treasury ratio stood at 93.5%, according to MMD.
Treasuries were stronger as stock prices traded lower. The Treasury three-month was yielding 2.002%, the two-year was yielding 1.757%, the five-year was yielding 1.701%, the 10-year was yielding 1.845% and the 30-year was yielding 2.316%.
The New York trader said the weakness was noticeable in munis Monday and pointed to the rise in 10-year Treasury yields to 1.83% as of midday Monday, up from 1.90% on Friday — and said both paled in comparison to when the 10-year was as low as 1.45% two weeks ago.
The strong economic numbers released last week also contributed to the shakeup of the market. He said the arrival of the Texas note deal two weeks, for instance, was one of the deal that brought the weakness to light. The one-year notes were priced with a 1.35% yield, he said. “Once they came in, it started shaking things up because of the adjusted yields and value,” he said.
The overall weakness in the face of the growing calendar is causing some defensiveness and apprehensiveness by traders.
“Guys are being very conservative here because they are not used to a down market,” he said, noting that the current climate is a “big adjustment for people.”
He added that “it’s probably what the market needs, but it’s painful when you see three point losses in your bonds.” At the same time, he said the new deals this week are doing well, "however, the secondary market is really lagging.”
Previous session's activity
The MSRB reported 28,884 trades Friday on volume of $10.28 billion. The 30-day average trade summary showed on a par amount basis of $11.21 million that customers bought $5.97 million, customers sold $3.30 million and interdealer trades totaled $1.94 million.
California, New York and Texas were most traded, with the Golden State taking 17.606% of the market, the Lone Star State taking 13.241% and the Empire State taking 12.275%.
The most actively traded security was the Rutgers University in New Jersey’s taxable GO 3.915s of 2119, which traded 13 times on volume of $34 million. The century bonds, originally priced at par to yield 3.915%, were trading on Friday at a high price of 98.25 cents on the dollar, a low yield of 3.986%. The bonds began initial trading on Wednesday, when they traded 67 timed on volume of $189 million at a high price of 100.498, a low yield of 3.895%.
Treasury auctions discount rate bills
Tender rates for the Treasury Department's latest 91-day and 182-day discount bills were higher, as the $45 billion of three-months incurred a 1.945% high rate, up from 1.920% the prior week, and the $42 billion of six-months incurred a 1.870% high rate, up from 1.825% the week before. Coupon equivalents were 1.987% and 1.919%, respectively. The price for the 91s was 99.508347 and that for the 182s was 99.054611.
The median bid on the 91s was 1.900%. The low bid was 1.850%. Tenders at the high rate were allotted 10.94%. The bid-to-cover ratio was 2.68. The median bid for the 182s was 1.840%. The low bid was 1.805%. Tenders at the high rate were allotted 81.11%. The bid-to-cover ratio was 2.74.
Data appearing in this article from Municipal Bond Information Services, including the MBIS municipal bond index, is available on The Bond Buyer Data Workstation. Click here for a brief tour of the Workstation.