Municipal market yields remained unbowed after Standard & Poor’s decision Friday to downgrade the credit rating of the United States.
But closer scrutiny of the day showed how general uncertainty and Standard & Poor’s upcoming decision over which muni credits to downgrade together pinned the muni market to the mat.
Municipalities showed no enthusiasm for pushing new issuance to market Monday and dealers demonstrated no desire to reach for the few bid-wanteds available in the day’s trading session. Muni yields, though not moving in lockstep with Treasury yields on the day, nonetheless continued their descent.
“It was a quiet, wait-and-see approach on everything,” a trader in New York said. “But if you were an issuer, you definitely didn’t want to bring a deal to market today. It would’ve been pretty nasty.”
Traders had varying opinions on the news’s effects on investor demand and trading in the markets.
A different New York trader said that the downgrade would not affect the day’s trading. In addition, he said, the markets will only reveal the ramifications over time. But there won’t be enough information this week to gain sufficient insight into the downgrade’s effect on munis.
“What will dictate,” a trader in Chicago added, “is how the primary market clears, to give some confidence to the secondary market.”
Muni yields were lower at the back end of the curve, as well as at various spots throughout, according to the Municipal Market Data triple-A scale. Yields through 2019 were steady, as were those between 2021 and 2035.
Those yields in 2020, as well as in 2036, ticked down a basis point. Maturities in 2037 fell two basis points, while yields maturing after that dropped three basis points.
The benchmark 10-year muni yield held steady, closing the day at 2.38%. It equaled its lowest yield in almost 10 months, dating to Oct. 21.
The two-year muni yield held at 0.35%, its lowest yield since Aug. 31, 2010. The 30-year muni yield fell three basis points to 3.92%, its lowest since early November.
Treasury yields started this week firmer across the curve in the wake of the news from Standard & Poor’s. The 10-year Treasury yield dropped 21 basis points to 2.35%, its lowest level since Jan. 20, 2009.
The two-year Treasury yield continues to challenge the record books. It reached 0.25% in the afternoon, before ending the session one basis point lower from Friday’s close, equaling the record low of 0.27%.
The 30-year yield tumbled 17 basis points on the day to 3.67%, its lowest point since Oct. 6.
Muni-Treasury ratios across the curve are off the charts, and far more favorable when compared with their 2011 averages. The 10-year muni-Treasury ratio, for example, sits at 101%, against an average of 90.4% for the year.
But that may not be enough to entice investors. “You could look at ratios and say: the asset class is tremendously cheap,” the Chicago trader said. “But when you look at the nominal yields for the credit that was just downgraded — the U.S.’s — in the back of your mind, you have to be concerned about how it affects state and local municipalities.”
Market pros point to a lack of supply as a reason muni yields have been falling. This week, the situation likely won’t improve.
The industry predicts that municipal bonds expected to be sold this week will total $2.25 billion versus a revised $3.24 billion last week. One trader in New York said he expects the deals to be absorbed, albeit likely at slightly wider spreads.
Beyond trading, there was no shortage of analysis on how much the U.S. downgrade would affect the muni market. To begin with, few municipal bond ratings are likely to move in tandem with the U.S. government ratings, wrote Janney Capital Markets’ Tom Kozlik in a recent report.
Those credits directly linked and, thus, most likely to be affected in the coming days include pre-refunded bonds, bonds backed by federal leases, and municipal housing ratings that are backed by the security of the federal government, Kozlik wrote. In general, he added, the largest connection between Standard & Poor’s downgrade and muni issuers will be through their dependence on federal spending.
And the news of the downgrade wasn’t necessarily a negative for munis, said Mike Pietronico, chief executive officer of Miller Tabak Asset Management. This is because, entering 2011, municipalities generally understood that monies from the federal government this year would be quite limited, he said. Thus, municipalities were well prepared, as far as getting their fiscal house in order.
Furthermore, there will likely be more reductions in government spending, Pietronico said. That reduction in spending will actually be beneficial to fixed-income valuations, he added, as inflation will begin to ebb.
And, in all likelihood, any rating action on bonds other than those directly linked to the federal government will be limited, wrote RBC Capital Markets’ Chris Mauro, in a report on the day. “S&P will attempt to quantify the impact of federal deficit reduction on state and local government budgets, but we think any rating changes resulting from this exercise will be minor,” he wrote.
His reasons? For one, federal discretionary spending makes up a small portion of state and local budgets, on average. By comparison, mandatory federal entitlement spending is a far more significant component. Subsequently, Mauro added, more considerable deficit-related fiscal pressure will affect the states if Capitol Hill ever manages to undertake meaningful entitlement reform.
The equities markets Monday clearly reflected disintegrating investor confidence far more than the muni market. Stock market participants reacted to the news of the Standard & Poor’s downgrade, general uncertainty, and overwhelming signs of a weak economy with fear and selling.
The three market indexes all fell by at least 5.55% on the day. For its part, the Dow Jones Industrial Average dropped by a staggering 634.76 points.