The uninterrupted weakness in the municipal market seen in the second half of February continued yesterday amid soft conditions, even as retail demand increased - resulting from tax-exempt yields Friday jumping to their highest levels in history relative to Treasuries - and tempered the continued sell-off.
Traders said municipal yields were higher by about two basis points on the short end and intermediate range, while seeing yield levels either flat or slightly lower on the long end.
"It's not quite as bad as Friday's bloodbath, but it's still fairly cheap out there," a trader in New York said. "We're seeing a lot of paper out there, and we hit a lot of 5% levels on Friday, and now we're seeing about three-quarters as many [of trades hitting 5%] as Friday."
"I think there's a lot of buyers and they are buying this up, and we will start to see yields pull in a bit over the week or so, all depending on how much more these funds start dumping paper into the market," the trader said. "If we continue the way we are now, we'll start to retract a bit. If not, we could see these levels for a little while, which would be great for retail. [Retail is] buying paper like crazy."
The Treasury market showed some losses yesterday. The yield on the benchmark 10-year Treasury note, which opened at 3.51%, finished at 3.54%. The yield on the two-year note was quoted near the end of the session at 1.62% after opening at the same level.
In economic data released yesterday, construction spending fell 1.7% in January, after a revised 1.3% drop the previous month. Economists polled by IFR Markets had predicted a 0.7% decline.
The Institute for Supply Management's business activity composite index decreased to 48.3 in February from 50.7 in January. Economists polled by IFR predicted the index would slip to 48.1.
In a weekly report released yesterday, Matt Fabian, managing director at Municipal Market Advisors, wrote that "supply and demand for municipal bonds are sliding more deeply out of balance."
"Auction failures persist despite the introduction of substantial new, albeit yield-oriented buyers," Fabian wrote. "This should continue for at least several weeks and auction-rate security yields are unlikely to dip close to former absolutes without significant supply contraction. Further, poor returns and ever-wider bond insurance worries are moving more regular variable-rate demand notes from customer to bank balance sheets, exacerbating funding and thus selling pressure."
George Friedlander, managing director and fixed-income strategist at Citi, wrote in a weekly report: "We can predict one thing with confidence - continued volatility in the muni market."
"Beyond that, it could be weeks or months before the distended patterns in the muni market begin to recede," Friedlander wrote. "The overhang of additional unwinds by hedged institutional investors, together with the overhang of potential new issues, could impede any rapid move back in the coming weeks. Nevertheless, in our view, the values available are unusual and compelling, and we believe that they will attract buyers."
In the primary market, a trio of super-sized deals will kick off March in the Texas, California, and Puerto Rico markets, on the heels of a fairly lackluster February. An estimated $10.16 billion is expected to be priced into a relatively weak municipal market clouded by failed auction-rate transactions and the problems still facing bond insurers as a result the general contraction in liquidity.
At least one of the deals - a $1.6 billion Puerto Rico Aqueduct and Sewer Authority new-money revenue and refunding offering - could get some keen attention from yield-hungry investors if underwriters decide to price the bonds without insurance and only on the merits of its Baa3 underlying rating from Moody's Investors Service and BBB-minus from Standard & Poor's and Fitch Ratings.
The two other mammoth offerings on tap this week include a highly market sensitive, $2.3 billion revenue refunding from the North Texas Tollway Authority and a $1.75 billion California GO sale.
Depending on market conditions, this week's upcoming NTTA deal could be priced by Bear, Stearns & Co. either tomorrow or Thursday. Except for the Series D CABs, the deal will carry ratings of A2 from Moody's and A-minus from Standard & Poor's. Fitch, meanwhile, downgraded the NTTA's outstanding debt to BBB-plus from A-minus earlier this week because of significant risks associated with the SH 121 project, which the agency said will more than triple its existing debt. At the request of the authority, however, Fitch was asked to withdraw its rating - even though it did not apply to the new bonds - because it marred the credit's A-category status.
In the Golden State, meanwhile, retail investors get first crack at the California GOs before the deal is priced for institutional investors tomorrow by Siebert, Brandford, Shank & Co. The retail order period began yesterday, and runs through today. The state's GO bonds are rated A1 by Moody's and A-plus by Standard & Poor's and Fitch. The deal is expected to mature from 2009 to 2038.
In the new-issue market yesterday, Goldman, Sachs & Co. priced for retail investors $491.7 million of second general highway and bridge trust fund bonds for the New York State Thruway Authority. The bonds mature from 2009 through 2028, with yields ranging from 2.83% with a 3% coupon in 2010 to 5.25% with a 5.2% coupon in 2028. Bonds maturing in 2009 were decided via sealed bid. The bonds, which are callable at par in 2018, are rated AA by Standard & Poor's and AA-minus by Fitch.