Taxable trend continues; flat muni curve could get flatter
The municipal market continues to flex its muscles even as the U.S. economy seems to be slowing, which could lead to an even flatter yield curve.
According to Dan Heckman, senior fixed-income strategist at U.S. Bank Wealth Management, the muni market right now is “pretty strong” with a “pretty flat” yield curve. After just an okay jobs report today, he said, further slippage may prompt concerns among market participants that the Fed will get more aggressive in cutting the Fed Funds Rate, leading to an even flatter muni yield curve.
“There are definitely signs of a slowing economy and if we get a China deal or even a China-light deal, I can see rates going lower,” he said on Friday morning. “I think an interesting development is the appetite or lack thereof on the shorter end of the curve, as buyers aren’t doing much there — specifically in the secondary market.
“As the year ends, we could have a flatter curve — as money managers will no doubt be scrambling to catch up on performance and duration,” Heckman said. “I get the sense that yields and rates could only go lower from here, but right now munis on a relative basis still look really attractive.”
The muni market is expected to see $6.42 billion of new deals this week, slightly lower from the revised total of $6.99 billion this past week. The calendar consists of $4.47 billion of negotiated deals and $1.95 billion of competitive sales. There are 23 deals scheduled $100 million or larger, with four of those coming being competitive deals.
Taxables once again have a strong presence with nine deals in total, including the three largest deals of the week.
“Tax equivalent yields, especially on long end, looks very, very attractive,” Heckman said. “If you can buy bonds at 100% or on tax equivalent basis more that’s pretty damn attractive.”
He added that in the corporate world, it’s hard to manage more than a single A credit rating and taxable or alternative minimum tax municipal bonds gives a manager the means to upgrade his or her portfolio in terms of both credit and spread gains.
“Because of this, you are seeing more and more crossover buyers come into munis,” he said.
Yingchen Li and Ian Rogow, municipal strategists at Bank of America Securities said in a recent research report that given the continued spread differential to non-AMT bonds, BofAS are overweight AMT bonds for non-AMT payers.
“We have expressed our constructive view on the spread value of bonds subject to AMT given the significantly lower probability that a taxpayer would be subject to the AMT post-tax reform,” they wrote in the report. “While there we focused on the individual, here we remind readers that tax reform also eliminated the corporate AMT. Currently, no corporations and just an estimated 200,000 individuals (down from 5.2 million in 2017) are subject to the AMT.”
They also noted that many filers got their first glimpse of AMT-free filings this past tax season. This led to increased demand for AMT bonds, resulting in compressed yield spreads compared to non-AMT bonds.
Looking ahead further
Citi is scheduled to price Massachusetts Water Resources Authority’s (Aa1/AA+/AA+) $596.970 million of general revenue refunding taxable green bonds on Thursday. The deal is expected to mature serially from 2020 through 2034 and a term bond in 2039.
Morgan Stanley is slated to price the University of Nebraska’s (Aa1/AA/NR) $513.405 million of facilities corporation university system taxable bonds on Thursday.
Siebert Cisneros Shank is set to price the District of Columbia Water and Sewer Authority’s (Aa2/AA+/AA) $343.465 million of public utility subordinate lien revenue refunding taxable bonds on Tuesday. The deal is expected to mature serially from 2020 through 2034 and have term bonds in 2039 and 2048.
Li and Rogow also noted the emerging trend of advance refunding using taxable bonds, adding that after the 2017 tax act, issuers have been searching for new techniques to advance refund their existing tax-exempt bonds. Low interest rates since the summer and relatively high muni/Treasury ratios spawned an emerging trend of advance refunding using taxable munis.
“We have seen quite a number of new deals so far. However, at this point, it is hard to predict how many refundings of this kind will come to the market in the short- term and 2020,” the report said. "We would like to provide some rough estimate about the pool of bonds that are potential candidates for such advance refundings.”
They continued to say that several points need to be clarified when they look for potential candidates for advance refundings with taxable bonds.
“First, the old Treasury rule regulating advance refunding of tax-exempt bonds by tax-exempt bonds would not apply here. As such, both existing new money and refunding bonds can be advance refunded by taxable munis if it is financial viable,” they said. “Secondly, tax-exempt bonds whose first call dates are within two years of maturity are unlikely to be advance refunded using this method, as the savings would not be high enough. Thirdly, tax-exempt bonds with first call dates in the next two years are less likely to be advance refunded as issuers may be more willing to wait current or forward refund them due to low rates outlook.”
They said that this may produce better savings. Finally, they added that the market needs to be aware that such new type of advance refunding activity would be high when Treasury rates are low and muni/Treasury ratios are high.
In the short-term sector, the New York Metropolitan Transportation Authority is expected to sell $600 million of transportation revenue bond anticipation notes on Thursday.
Heckman said that there are another couple of Interesting developments he has been seeing in the primary market.
“It seems as though 3% coupons are the new 4% coupons, in terms of preference of buyers,” he said. “We have not been seeing a lot of higher coupons and we are more focused on the 3s and 4s at the most.”
He noted that he is not too excited about 2% coupons or 5% coupons and higher and it seems to be the case with a lot of money managers. The other trend he has been noticing are that issuers are going away from the 10-year call structure and it seems as though those issuers are not being penalized enough in terms of additional spread for less call protection.
“As a buyer, you want as much call protection as you can get, so that when rates drop you have that safety net,” Heckman said. “We have been seeing call protections in the five to eight year range and it is definitely a development to watch for, as it could be impactful if we see another leg of long term lower interest rates. Bond buyers will have to be very careful of, and will need to get more compensation for more risk.”
Lipper sees smaller inflow
For 39 weeks in a row investors have poured cash into municipal bond funds, according to the latest data released by Refinitiv Lipper on Thursday.
Tax-exempt mutual funds that report weekly received $883.952 million of inflows in the week ended Oct. 2 after inflows of $1.637 billion in the previous week. This marks the fifth time in the past 12 weeks inflows have been less than $1 billion, including the fourth time in the past five weeks.
Exchange-traded muni funds reported outflows of $21.505 million after inflows of $275.726 million in the previous week. Ex-ETFs, muni funds saw inflows of $905.456 million after inflows of $1.361 billion in the previous week.
The four-week moving average remained positive at $915.232 million, after being in the green at $889.269 billion in the previous week.
Long-term muni bond funds had inflows of $558.384 million in the latest week after inflows of $1.516 billion in the previous week. Intermediate-term funds had inflows of $228.241 million after inflows of $267.395 million in the prior week.
National funds had inflows of $767.441 million after inflows of $1.386 billion in the previous week. High-yield muni funds reported inflows of $209.214 million in the latest week, after inflows of $427.837 million the previous week.
Munis were stronger on the MBIS benchmark scale, with yields falling by one basis point in the 10-year maturity and by two basis points in the 30-year maturity. High-grades were also stronger, with yields on MBIS AAA scale falling by one basis point in both the 10-year and 30-year maturity.
On Refinitiv Municipal Market Data’s AAA benchmark scale, the yield on both the 10- and 30-year GOs dropped one basis point to 1.32% and 1.91%, respectively.
The 10-year muni-to-Treasury ratio was calculated at 85.9% while the 30-year muni-to-Treasury ratio stood at 94.4%, according to MMD.
Treasuries were lower as stocks were trading in the green. The Treasury three-month was yielding 1.703%, the two-year was yielding 1.384%, the five-year was yielding 1.333%, the 10-year was yielding 1.515% and the 30-year was yielding 2.019%.
Week's actively traded issues
Some of the most actively traded munis by type in the week ended Oct. 4 were from Colorado, Florida and Puerto Rico issuers, according to IHS Markit.
In the GO bond sector, the Lower Colorado River Authority, Texas, 4s of 2049 traded 19 times. In the revenue bond sector, the Alachua County Health Facilities Authority, Fla., 4s of 2049 traded 47 times. In the taxable bond sector, the GDB Debt Recovery Authority of the Commonwealth of Puerto Rico 7.5ss of 2040 traded 27 times.
Week's actively quoted issues
Wisconsin, New Jersey and California bonds were among the most actively quoted in the week ended Oct. 4, according to IHS Markit.
On the bid side, the Wisconsin Public Finance Authority, revenue 4.5s of 2042 were quoted by 35 unique dealers. On the ask side, the New Jersey Transportation Trust Fund Authority revenue 3.5s of 2046 were quoted by 163 dealers. Among two-sided quotes, the State of California taxables 7.55s of 2039 were quoted by 20 dealers.
Previous session's activity
The MSRB reported 35,499 trades Thursday on volume of $17.681 billion. The 30-day average trade summary showed on a par amount basis of $11.11 million that customers bought $5.98 million, customers sold $3.24 million and interdealer trades totaled $1.89 million.
California, New York and Texas were most traded, with the Golden State taking 17.167% of the market, the Empire State taking 10.505% and Lone Star State taking 10.235%.
The most actively traded security was the New Jersey Transportation Trust Fund Authority, 3.5s of 2046, which traded 72 times on volume of $46.85 million.
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.