Municipal Bond Market Update - Mar 1

MARKET UPDATE

While fundamentals and technicals argue for a setback, the trigger to weakness is unclear.

RECOMMENDATION

Pricing strength has rallied strongly along the front of the curve, credit spreads continue to tighten accordingly. Income opportunities remain much farther out where institutional demand has been less secure and there is more risk of a pricing impact should Treasury yields begin to rise. That being said, total return opportunities across the curve are likely to be of the value preservation and relative value type versus absolute gain. For the former, continue to look to the belly (5-15yrs) where, despite a rally to “at risk” levels, momentum remains strongest and may be most durable.

INVESTING STRATEGY

Even though we have just passed two major debt service payment dates in December and January, safe sector credits are still largely absent from the group of issuers disclosing trouble. This is a promising development, but obviously, there are likely still several years of challenged budgets ahead.

SUMMARY

Scarcity of well-rated, tax-exempt municipal bonds continues to support very low nominal yields on municipal bonds, with an assist last week from a stronger Treasury market. Throughout the crisis, municipals have been variously treated as a safety instrument (that moves with Treasuries) and a spread product (that moves counter, generally). At this point, there are enough buyers along most of the yield curve to outweigh increasingly hyperbolic reporting on the looming credit crisis in our sector. And, while the situation in Greece does not have a clear analog in the municipal market, there are implications for increased regulation going forward. The buyers scared off by the muni-scare articles are so far in the minority, as we note that credit spreads continue to tighten aggressively, in particular along the front of the yield curve where individual investors provide the backbone of demand. In fact, spreads up front now approximate pre-crisis levels and, adjusting for pre-crisis issuer payments for bond insurance, this may be the most credit-friendly environment in years. Last week, two senators launched a bill that would end issuers’ use of tax-exempt bonds and/or BABs after this year, but the prospects for passage are extremely poor. On the other hand, the SEC finally published their long awaited final reforms for the money funds—changes are not nearly as dramatic for our sector as they could have been but will still likely drive downward pressure on yields at the very front of the curve for the foreseeable future.