There weren’t a lot of reasons to trade municipal bonds Monday, and the market acted accordingly.
There wasn’t any significant size issued in the primary market. There weren’t any indicators on the U.S. economy. Subsequently, there was little action in the secondary market or with yields.
And while Treasuries and equities reacted to investor concerns about Greece’s ability to pay down its debt, as well as the finances of various European banks, munis stood firm. “We just hung in there,” a trader in New York said.
With little activity in the primary and secondary markets, the Municipal Market Data scale held steady across the curve throughout the day. The benchmark 10-year yield Monday held at a record low of 2.07%, as measured by MMD.
The 30-year yield remained unchanged at 3.66%, its lowest level in at least three decades. The two-year yield stayed at 0.30% for a 23rd consecutive session, hovering at its lowest level in more than 40 years.
Treasury yields closed today’s session mostly weaker. The 10-year benchmark yield rose three basis points to 1.95%, though still lingering at levels it hasn’t seen in roughly five decades.
The 30-year yield remained unchanged at 3.25%. The two-year yield climbed four basis points to 0.22%.
Investor fears of a debt default in Greece and apparent fragility in the European banking system pushed cash out of the equities markets into Treasuries, according to a Rockfleet Financial Services newsletter. This, in turn, has helped munis, as ratios to Treasury yields have been drawing taxable investors into the municipal market and adding to its overall firming.
By Friday afternoon, 10-year, triple-A munis were trading at 108% of the comparable Treasury notes, Rockfleet reported in its newsletter. At the same time, 30-year, triple-A munis were trading at 112% of the comparable Treasury bonds.
According to a Bloomberg report, muni bond sales around the Labor Day — from Aug. 29 through Sept. 9 — were the lowest seen in the past seven years. During this period, states and cities sold approximately $5 billion in tax-exempt debt.
Volume in the primary seems to be gradually rising from last week’s measly level. New issuance for this week is expected to be $4.65 billion, not including $5.4 billion of California revenue anticipation notes. Estimates for last week’s volume were revised downward to $1.95 billion.
Approximately half of this week’s issuance will be refundings, including almost $1 billion worth of New York paper, JPMorgan analyst Peter DeGroot wrote in a recent research report.
“We believe the primary market will be well-bid given the recent lack of supply, large September reinvestment, and recent better fund flows,” DeGroot wrote. “The significant pent up demand should allow for ample liquidity throughout September despite low and highly volatile yields.”
But supply may begin to weigh on the market in October, he added. This is will likely be due to the current and anticipated increase in refundings, average weekly volume in the $6- to $7-billion range, a decline in reinvestment capital, and persisting low yields.
Through the end of last week, year-to-date muni issuance stood at $158 billion as municipal governments focus on reducing costs, Justin Hoogendoorn, a muni analyst for BMO Capital Markets, wrote in a recent report. He predicts primary market volume will total somewhere between $240 and $260 billion in 2011 — considerably off the pace of the $400-$430 billion the market saw during the previous six years.
“We expect issuance to possibly recover to a $300 billion level in fiscal year 2012, yet remain lower than previous years,” Hoogendoorn wrote. “For now, low issuance primarily stems from state and local governments taking action to cut spending via job-shedding and cost-cutting.”
There are those in JPMorgan’s fixed-income group who see opportunities in munis’ wide credit spreads, DeGroot wrote.
In fact, they have a “high probability” of tightening in the near term, he added. The spread product will perform well given investors’ inclination for yield in the environment of drawn out low-rates, limited lower-rated supply, high reinvestment capital, recent mutual fund inflows, and wide spreads among As and triple-Bs.
“We believe investors should favor adding credit risk in the belly of the curve rather than interest rate risk in the longer portion of the curve,” DeGroot wrote.
And in spite of the numbers, investors don’t appear worried about how munis have performed, of late, BMO’s Hoogendoorn wrote. He cites indexes that Bank of America Merrill Lynch has assembled that compare munis performance with Treasuries in July and August. And in those two months, munis returned 2.6% over the period, or a 16.8% annualized total return.Yet, they underperformed Treasuries by 2.5% on a relative basis. This was the largest two-month underperformance since 2009, according to Hoogendoorn. But municipal bond holders haven’t complained about the performance over the period.
In the same vein, Build America Bonds and other taxable munis have now returned 15.5% on the year. And they’ve seen a 151-basis-point outperformance year to date, against Treasuries of similar duration.
“However, rather substantial taxable muni underperformance in August, as spreads to Treasury levels widened by around 40 basis points in the 10-year area, has created opportunity,” Hoogendoorn wrote. “Therefore, in spite of many municipal bond yields falling to the lowest rates since the early 1950s, the sector — on both sides of the tax situation — continues to look attractive on a relative basis to Treasuries.”
The equities markets, particularly the Dow Jones Industrial Average and the S&P 500, were knocked down by 1.49% at one point in today’s trading. But they bounced back by the session’s end. The Dow ended the day down by almost 69 points.