The tax-exempt market was dominated in the past week by headlines concerning the government shutdown, the debt ceiling, Puerto Rico downgrades, and continued outflows from municipal bond funds, all creating a push-and-pull in the marketplace that left yields unchanged.
Earlier in the week, traders said the municipal bond market felt firmer, as grid lock in Washington spurred demand for safe haven assets like fixed-income. As the week progressed, an increase in outflows from municipal bond mutual funds to almost $700 million from the previous week’s $159 million, and a downgrade of Puerto Rico’s Sales Tax Financing Corp. bonds by Moody’s Investors Service, left the muni bond market on a softer note.
“The smaller deals did well this week and the moves in rates were appropriate,” said Adam Mackey, head of muni fixed income at PNC Capital Advisors. The largest deal of the week, $900 million of Chicago O’Hare International Airport looked expensive, he said. “O’Hare did fairly well at spreads that were tight. I’m not sure it was priced to move.”
The most demand for munis remains on shorter-maturing bonds. “Inside 20 years has firmed a little bit coming off a free fall through August,” Mackey said. “Inside 10-years, demand is insatiable. And the five-year range is bulletproof. There is a built-in tail wind for the front end of the curve.”
With only $2.79 billion in new deals this week, the market was able to take a breather after what has been a whipsaw the last five months. “The market is exhausted,” Mackey said. “There has been so much volatility in the last five months.”
From May to August, municipal bond yields climbed to 2.94% on the 10-year Municipal Market Data scale on Aug. 30 from 1.66% on May 1. The 30-year yield rose to 4.45% from 2.79% during that time period. Then in September, yields fell from 3.02% to 2.54% on the 10-year and from 4.49% to 4.12% on the 30-year.
After the “no-taper rally” prices are starting to look expensive again and retail is taking a step back. “The street gets back involved and starts to provide a floor with a no-taper rally and retail starts to back out as rates stabilize and go lower and you get whipsawed back,” Mackey said. “This week was a breather.”
For the week through Thursday, the 10-year and 30-year yields were steady at 2.54% and 4.11%, respectively. The two-year yield increased one basis point to 0.37%.
The 10-year and 30-year Municipal Market Advisors yields fell one basis point for the week through Thursday to 2.69% and 4.26%, respectively. The two-year was steady at 0.54%.
The Treasury yield curve steepened throughout the week. The two-year yield fell one basis point for the week through Friday to 0.33%. The benchmark 10-year yield rose two basis points to 2.65% and the 30-year yield climbed four basis points to 3.73%.
Looking to the fourth quarter, Mackey said he expects to see stability and depth as tax swapping and limited supply provide some footing. "We are cautiously optimistic. I don't care if rates go higher or lower as long as it's orderly and there are interested parties on both sides. Even if rates go higher, that's fine as long as it's not 30 basis-point-cuts in two days."
Still, the headlines are expected to continue. Moody’s downgraded Puerto Rico’s COFINA bonds to A2 from Aa3 late Thursday with a negative outlook, but affirmed the GO rating at Baa3 with a stable outlook.
"Puerto Rico is at bat. Three months ago it was on deck. The market is treating it as junk and the rating agencies aren't. Credit and pricing stress is creating dilemmas for all parties involved particularly the Puerto Rico issuers."