Continued weakness has permeated through the municipal market over the past two weeks, leading to the second prolonged disengagement of tax-exempts from the Treasury market in the past seven months - and a dramatic rise of The Bond Buyer's weekly yield indexes.
"The bid side is extremely weak. Munis are getting extremely cheap here, and I think it's for a number of reasons," said Gary Strumeyer, managing director at BNY Capital Markets. "I think you're seeing an increased supply of bonds overall as auction-rate securities get refinanced longer term. And I think there's definitely a distraction factor, where I think a lot of firms are focusing on their auction-rate markets and it's really a distraction."
George Strickland, managing director and portfolio manager at Thornburg Investment Management, said the woes in the market began as "sort of an unwinding of the long munis, short Treasuries trade," but it has now "gone well beyond that."
"I just get the feeling that no one really wants to step in front of this thing right now," he said. "You buy something, and the next day you're underwater with it."
Strickland said that the continuation of current market conditions would affect new-issue supply to the extent that "certainly no refundings can happen in this kind of environment, unless perhaps you're refunding an auction-rate bond."
However, Evan Rourke, portfolio manager at MD Sass, said that while refunding deals will be on the sidelines, there will be "fix-outs of variable-rate securities to replace them."
"In terms of supply, I think overall supply will change, but you'll still have plenty of supply, as these auction-rate deals fix out," Rourke said. "And they're talking about the [variable-rate demand notes] fixing out as well, so I think you'll have a change there. So that should make up for the loss of refunding deals."
Even as the municipal market has weakened over the past two weeks amid fairly light supply, with an increased primary calendar on the horizon, there are questions as to how the market will handle the anticipated influx, given the already weak conditions.
"Our calendar all year has been relatively light," Rourke said. "The next couple of weeks, we're finally starting to hit some steam on some volume on the calendar, so how is that going to play out in a market where the bid side is just incredibly weak? It's going to be pretty interesting."
For example, next week, three deals in excess of $1 billion will be priced. Bear, Stearns & Co. will price $1.8 billion of bonds for the North Texas Tollway Authority, Siebert, Brandford, Shank & Co. will price $1.7 billion of debt for California, and Citi will price $1.3 billion of bonds for the Puerto Rico Aqueduct and Sewer Authority.
"The history of the muni market is that we've gotten cheaper into supply, and then not during it, most of the time," added George Friedlander, managing director and fixed-income strategist at Citi. "So I'm not terrified about when it gets here, but we needed to cheapen up to get ready for it."
Friedlander said that though the market is seeing its share of turmoil now, he thinks stability is close.
"We've gotten cheap enough, and we're starting to see a lot more retail," he said. "I think we're close."
However, Strickland, who is not seeing quite as much retail demand at this point, is not sure a turnaround is around the corner.
"I think retail right now is in shock. They're either stuck in auction-rate preferreds, or they're afraid of the bond insurers, they're afraid of the whole muni market, which is a little irrational, but it's there," he said. "Retail should be two-thirds of demand, and right now, I won't say it's nonexistent, but it's in short supply. Turnaround in retail demand, I think, will come when we get close to the bottom of the barrel in [tender-option bond] unwinding, but that's the problem."
Strickland continued to state that he doesn't think TOB program unwinding is "even half done."
"That's the cloud hanging over the market, and if we see a lot more of that selling pressure on the marketplace, then this thing could go on for at least a few more weeks," he said. "I would guess we'll see an uptick in retail demand by the summer, and maybe TOB unwinding will be about done by then, so my best guess would be sometime around mid summer, we might see more stability in the marketplace, but probably not until then."
Rourke said that the key to getting out from behind the weakness will be identifying who will emerge as "the buyer of last resort."
"At different points in the market, we've had different buyers of last resort," Rourke said. "You can go back 20 years now, when dealers would step in and say, 'OK, that's enough, these things are cheap.' You had insurance companies as the buyer of last resort in the early to mid '80s. They just said, 'OK, we have cash, and when they're at our level, we'll take them.'"
More recently, Rourke said, the corrective bid had come from the arbitrage and leveraged accounts. However, "those are the same people that are now selling at spreads that are cheap."
"Historically, if you put on a trade at 80% of Libor because you thought it made sense, or 90% of Treasuries because you thought it made sense, well, it's 100% of Treasuries now, and 90% of Libor," Rourke said. "So they're not providing that corrective bid. You have dealers who seem to be struggling due to other issues. You have the arbs being a seller in the market. I don't think fund flows are going to quite pick it up."
However, Rourke said, retail investors should ultimately "take advantage of good relative value."
"You have 5% available in the long end now, pretty readily. For an individual investor in a top tax bracket, that's almost a 7.70% yield. That's compelling," he said. "So I think you'll get that, but retail is certainly not going to be able to absorb a volume of concentrated selling."
Regardless, Rourke said, "at some yield, you do have someone who says, 'This is silly. These are so cheap. I want in.' But what that yield is, we don't know yet. We're not there yet."
"I think we'll see conditions like this certainly for a few more days at least," Rourke added. "Heading into the end of this month, I don't see anyone really focused on stepping up. But this is one of those things where you may miss the first 10 basis points or two ratios correction, because it will happen quickly, once that buyer steps in or once that selling pressure abates."
The 20-bond GO index rose 45 basis points this week to 5.11%. This is the highest the index has been since May 20, 2004, when it was 5.13%, and the first time the index has been above 5% since June 24, 2004. It is the largest one-week increase in the index since Dec. 23, 1993, when the index rose 60 basis points, and the largest one-week change since Dec. 29, 1993, when the index dropped 66 basis points.
The 11-bond GO index rose 46 basis points this week to 5.02%. It is the highest the index has been since June 10, 2004, when it was 5.02%. It is the largest one-week increase in the index since Dec. 23, 1993, when it rose 63 basis points and the largest one-week swing since Dec. 29, 1993, when it fell 69 basis points.
The revenue bond index rose 28 basis points this week to 5.22%, which is the highest the index has been since July 6, 2006, when it was 5.31%. It was the largest one-week increase in the index since Dec. 23, 1993, when it was 69 basis points, and the largest one-week movement since Dec. 29, 1993, when it dropped 75 basis points.
The 10-year Treasury note yield fell eight basis points this week to 3.68%, which is the lowest since Jan. 31, when it was 3.64%.
The 30-year Treasury bond yield fell one basis point to 4.53%, which is the lowest since Feb. 7, when it was 4.52%.
The one-year note index rose 18 basis points this week to 2.27%, which is the highest since Jan. 16, when it was 2.57%.
The weekly average yield to maturity of The Bond Buyer 40-bond municipal bond index rose 17 basis points this week to 5.13%, which is the highest since the week ended July 29, 2004, when it was also 5.13%.
The 40-bond index contains 40 long-term municipal bonds. Taxable municipal bonds are not eligible for inclusion, but municipal bonds subject to the alternative minimum tax for individuals and corporations are eligible. Noncallable bonds became eligible for inclusion in 1995.
The index's value is calculated by taking the dollar bid price for each bond, converting it to represent what the price would be if the bond had a standard 6% coupon rate, average the converted prices, and multiplying the results by the current value of the coefficient. The coefficient compensates for the changes made twice a month in the composition of the index.
The 20-bond index is based on a set of GO yields maturing in 20 years. The average rating of the 20 bonds is roughly equivalent to a Aa2 rating from Moody's Investors Service and a AA rating from Standard & Poor's.
The 11-bond index is based on a subset of the 20-bond group, and its average rating is roughly equivalent to Aa1 from Moody's and AA-plus from Standard & Poor's.
The revenue bond index uses 25 bonds maturing in 30 years. Its average rating is roughly equivalent to A1 from Moody's and A-plus from Standard & Poor's.
There is no average rating equivalent for Fitch Ratings for the indexes because Fitch does not rate all of the bonds.