Bonds Cheapest in 7 Months Propel Treasury Sales: Muni Credit

Photographer: Jin Lee/Bloomberg

Gary Pollack, head of fixed-income trading at Deutsche Bank's private-wealth unit said, “It’s attractive enough given the supply and demand dynamics to warrant a crossover trade.” Close

Gary Pollack, head of fixed-income trading at Deutsche Bank's private-wealth unit said,... Read More

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Photographer: Jin Lee/Bloomberg

Gary Pollack, head of fixed-income trading at Deutsche Bank's private-wealth unit said, “It’s attractive enough given the supply and demand dynamics to warrant a crossover trade.”

U.S municipal debt is the cheapest in seven months relative to Treasuries, luring buyers such as Deutsche Bank AG and signaling demand for local bonds as states and cities are poised for their biggest issuance week of 2013.

At 1.93 percent, yields on 10-year benchmark munis compare with the 1.71 percent interest rate on Treasuries with a similar maturity, data compiled by Bloomberg show. A rally in federal debt following a weaker-than-projected U.S. labor report pushed the ratio between the two yields to 113 percent, the highest since August.

That figure is a measure of relative value between the two asset classes, and it has climbed high enough to lure Deutsche Bank’s private-wealth unit in New York, which manages $12 billion of bonds. Last week, the group sold five- and 10-year Treasuries and bought tax-exempts, said Gary Pollack, head of fixed-income trading at the group, an affiliate of Europe’s second-largest bank.

“It’s attractive enough given the supply and demand dynamics to warrant a crossover trade,” he said in an interview.

Calendar Crush

California’s $2 billion tax-exempt deal and a $2 billion taxable Florida Hurricane Catastrophe Fund Finance Corp. sale lead about $10 billion of planned offers this week, the biggest wave since December in the $3.7 trillion municipal market, Bloomberg data show.

States and cities are borrowing as interest rates on 20- year general-obligations were 3.96 percent last week, below the 52-year average of 5.88 percent, according to a Bond Buyer index.

Treasuries gained April 5, pushing 10-year yields to the lowest level in almost four months, after a Labor Department report showed payrolls grew by 88,000 workers in March, the least in nine months. The median forecast of 87 economists in a Bloomberg survey was for an increase of 190,000.

Munis didn’t keep up in the rally and are trailing Treasuries this month, earning 0.3 percent while federal debt gained 0.6 percent, Bank of America Merrill Lynch data show.

Investors are typically willing to accept lower yields on local debt than on Treasuries because of munis’ tax-exempt status. For 10-year maturities, muni yields have averaged about 93 percent of Treasury yields since 2001, highlighting the appeal of the latest leap in the ratio.

Buyer Draw

“It brings in pension funds and other types of institutional investors that don’t need tax-exempt income, so that’s good for munis,” Pollack said.

The yield difference is even greater between munis rated AA, two steps below the top, and federal debt. At 2.32 percent, yields on 10-year munis rated AA are 126 percent of those on benchmark Treasuries, Bloomberg data show.

“There are people out there who see munis as pretty attractive,” said Clark Wagner, fixed-income director at First Investors Management Co. in New York, which manages $1.6 billion of the obligations.

In the five-year trade, Pollack sold Treasuries and bought a U.S. state rated AAA. He plans to reverse the deal when the ratio falls back toward its historical average, “in the low 90s,” he said.

Tax Pattern

While the relative cheapness of tax-exempt debt may help states and cities borrow this week, portfolio managers are still dealing with falling demand from individuals as tax season winds down.

Investors have pulled about $791 million from U.S. muni mutual funds during the past five weeks, the most since year- end, according to Lipper US Fund Flows data.

Outflows tend to occur as investors sell munis to make tax payments before the April 15 filing deadline, Pollack said.

“Once you get past April 15, we get inflows,” Pollack said.

The bulk of the withdrawals are coming from longer-dated funds. Investors pulled about $1.1 billion in the five weeks ending April 3 from funds with maturities greater than 10 years, according to Lipper data. In the same period, funds focusing on maturities from three to 10 years had about $3 million of withdrawals.

As more muni investors avoid longer-dated debt, yields on shorter maturities are falling faster.

Top-rated munis due in 30 years yield about 1.3 percentage points more than 10-year benchmarks, near the widest difference since August, Bloomberg data show.

To contact the reporter on this story: Michelle Kaske in New York at mkaske@bloomberg.net

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net

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