Municipal Bond Market Update - March 29

MARKET UPDATE

A selloff last week has given more yield for retail buyers.

RECOMMENDATION

The curve has changed dramatically in a week; earlier maturities are providing less certain asset preservation and liquidity, forcing some accounts to swap into longer paper. Intermediates are thus better placed for overall resilience; at some point, the front end should sell off again when rates begin to rise. Still, the hazard may be worse in waiting; long bonds have shown better relative demand and, because yield will reasonably be chronically scarce for years, investors may have an opportunity at present to acquire high grade income. Spread product may be more at risk if fund inflows slow.

INVESTING STRATEGY

With both Moody’s and Fitch not pursuing rating reform by the end of April, the muni market has begun an important transition to a less-credit/rating sensitive market. This may have important implications for investors, issuers, and dealers; everyone should be discussing related strategy in the context of their own business models.

SUMMARY

Munis were substantially weaker last week, with accounts impelled by soft Treasury auctions to realize gains and address near-term risks by moving farther out along the yield curve. Tax-related selling facilitated the upward shift in yields. By Friday, the tax-exempt curve had flip flopped; aggressive levels up front had turned concessionary and a formerly buyer-friendly long end appeared aggressively priced for the first time in months. Importantly, the sell-off was concentrated in high grades, weakness in which only tightened credit spreads. Thus, this was not an anti-muni or credit-related problem, but more a technical sell-off in sympathy with Treasuries. This week, the primary market is the smallest of 2010, giving the economic data poll position. In particular, investors are looking at the Friday employment reading to indicate whether or not things are actually getting much better. MMA’s market projections are based on assumptions of weak employment growth this year, but an unexpectedly large number on Friday could cause a reassessment. Finally, Fitch announced their own pursuit of “rating recalibration” by the end of April, helping the subtle-trade up in lower rated credits, in particular CA. The state’s huge taxable/BAB issue was met with strong demand and oversubscription and traded up aggressively in the immediate secondary market.