Municipal Bond Market Update - Mar 9

MARKET UPDATE

Low yields are limiting gains despite very strong demand for tax-exempts.

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 and through “at risk” levels, momentum remains strongest and may be most durable.

INVESTING STRATEGY

Whereas large CA bond sales have recently been credit spread wideners—by giving yield hungry investors a safe, liquid alternative to lower rated health care and the like—the sale this week may come with more robust pricing and thus help spreads actually tighten at the intermediate and long ends.

SUMMARY

The municipal bond market remains very well bid, with torrid and unrelenting demand from retail and other clients supporting both low nominal yields and tight credit spreads, in particular within 15 years. Longer buyers remain a bit more diffident but still aggressive. We do note a dramatic increase in institutional gains taking last week that helped offset an overall softer tax-exempt new issue calendar, however, even Friday’s pointed losses in the Treasury market were insufficient to budge long munis off their strong premium pricing. This week, tax-exempt supply returns with a $2Bn state of CA loan that we expect will attract solid demand, despite what should be a very difficult budget season beginning later this month. There are also a large number of Build America Bond sales that will keep up the scarcity in high grade, tax-exempt supply. Thus prospects are again favorable for municipals this week, and our near-term expectation is for more of the same, in particular at the front of the yield curve. Farther out along the curve, tax-exempts are also well positioned this year, although a likely increase in Treasury supply (and structural improvement in Treasury demand) may make life difficult for products competing with Treasuries for investors. Finally, this week we look at Vallejo, CA’s ongoing bankruptcy situation. The city’s working plan entails a three year deferral of debt service payment and interest accrual but ultimate repayment at 100% of par.

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