The tax-exempt market gained Monday, blindly following Treasuries as the primary and secondary markets offered no guidance.
“It’s going to be really quiet going through year-end,” said a trader in Chicago. “Treasuries have continued to rally and munis won’t perform until the New Year,” he said, noting that $22 billion in coupon payments are coming due Jan. 1 and supply is hovering around $2 billion to $3 billion. “So there is a lot of stuff that could potentially get done.”
The trader added that everything is looking cheap at this point, saying, “All the taxables and everything look really favorable.”
Monday was mostly slow, but by afternoon, the secondary market started to show signs of life.
“It’s quiet but firm,” said a trader in Atlanta. “It seems like there is a little activity in the secondary. Obviously it is a light new-issue week but people at least are getting stuff done.”
He added there was a “decent bid list and enough activity to stay at your desk.”
Munis were flat to firmer, according to the Municipal Market Data scale. Yields inside the three-year were unchanged, while yields on the four- and five-year dropped two basis points. The six- to eight-year maturities were unchanged, but the nine- to 14-year yields fell one basis point. Yields on the 15- to 23-year maturities were flat, while yields beyond the 24-year maturity fell one basis point.
On Monday, the 10-year municipal yield fell one basis point to 1.92%, falling five basis points in the past week. It set a new record low Monday after first setting the record last Friday when it fell below the 1.97% record set in September when the Federal Reserve announced its “Operation Twist.”
The 30-year muni yield fell one basis point Monday to 3.61%, falling eight basis points in the last week. The two-year yield closed flat at 0.36% for its ninth consecutive trading session.
Treasuries rallied Monday, continuing gains from Friday. The benchmark 10-year yield fell four basis points to 1.81% and the 30-year yield fell seven basis points to 2.79%. The two-year yield closed flat at 0.24%.
In the primary this week, $905.3 million of new issuance is expected, including $365.5 million in negotiated deals and $539.8 million in competitive sales, with the majority coming Tuesday.
On Monday, the biggest deal came in the competitive market. JPMorgan won the bid for $94.7 million of Collier County, Fla., special obligation refunding revenue bonds. The credit is rated AA by Standard & Poor’s. Pricing information was not available at press time.
In the negotiated market Monday, RBC Capital Markets priced one of the biggest deals, $20 million of Cleveland Municipal School District school improvement refunding bonds. The credit is rated AA by Fitch Ratings. Further details were not available.
Looking forward to Tuesday, Massachusetts is expected to sell $400 million of general obligation bonds, followed by Suffolk County, N.Y., issuing $300 million of short-term notes. The county is expected to offer an additional $100 million of short-term notes on Wednesday.
Muni-Treasury ratios are up for the week. Last Friday, the five-year muni-to-Treasury ratio increased to 114.8% from 110.5% the week earlier. The 10-year muni-to-Treasury ratio increased to 104.3% from 97.5%, and the 30-year ratio increased to 127% from 121% from the week before.
“Attractive ratios to Treasuries kept this asset class a recommended investment by pundits,” wrote MMD’s Randy Smolik.
And indeed, analysts are noticing the high muni-Treasury ratios. “Elevated spreads and ratio levels reflect unlikely secular risks, and at current levels, price in a moderate adjustment to the tax exemption,” wrote Michael Zezas at Morgan Stanley. “As a result, on a tax-adjusted basis, munis, and revenue structures in particular, should benefit from favorable long-term carry comparisons to investment alternatives among the traditional investor base.”
Because of the recent underperformance of munis compared to Treasuries, other analysts think the taxable sector is attractive. “The significant decline in longer-dated Treasury yields has created an opportunity for buyers of higher-quality longer-dated bonds to access taxable municipals at adjusted spreads to Treasuries,” wrote Peter DeGroot, muni strategist at JPMorgan. “Spreads in the taxable municipal market are wider versus Treasury bonds for a number of reasons, including lower absolute yields, strong performance versus corporates, and a limited buyer base.”
Looking forward to 2012, analysts are recommending the intermediate sector. DeGroot points to an overweight to the eight- to 13-year munis to “capture outsized curve roll and strong liquidity.” He said that part of the curve is expected to offer 369 to 454 basis points of return, except for the 10-year, which is a little lower. “These points on the curve exhibit better liquidity, tax-risk, and interest rate risk versus similar performing maturities.”
Similarly, Zezas recommends going outside the eight-year but extends the recommendation to the 18-year muni. “A modest duration extension is advisable given recent curve-steepening without concurrent change in the underlying economic, monetary, or fiscal policy outlook,” he said.
However, the Chicago trader said he is gravitating towards longer out on the curve. “The curve is really steep and it’s really the 15- to 25-year sector that is the cheapest part of the curve. People need to wake up to that part of the curve.”
But until the New Year, MMD’s Daniel Berger continues to tout the five-year muni. “Munis have underperformed Treasuries across the yield curve for most of 2011 but we feel that the five-year range has the best potential for the highest rate of appreciation should the muni-to-Treasury ratio revert back to its mean.”
