Biggest Supply Wave Since July Means Treasuries Win: Muni Credit
The U.S. debt-ceiling deal has unleashed the biggest wave of municipal borrowing since July, driving local bonds to the cheapest in almost two months versus Treasuries and luring buyers such as Deutsche Bank AG’s private-wealth unit.
The borrowing spike has prevented munis from keeping pace with a Treasuries rally after the 16-day federal shutdown that ended Oct. 17. The yield on 10-year munis reached about 111 percent of that on federal securities this week, the most since Aug. 29, data compiled by Bloomberg show. That signals a buy to investors betting the supply wave won’t last.
“Given the elevated muni-Treasury yield ratios and a large increase in supply, this presents itself as an opportunity for the municipal investor,” said Gary Pollack, who oversees $6 billion of munis as head of fixed income for the Deutsche Bank unit in New York. He said his company has been buying bonds from issuers in the primary market this week.
Led by California, localities are offering $8.1 billion of debt this week, the most since mid-July, Bloomberg data show. The $3.7 trillion municipal market has earned about 0.1 percent this month, compared with 0.6 percent for Treasuries, Bank of America Merrill Lynch data show.
Even California’s issuance isn’t enough to push annual volume above last year. Bank of America Merrill Lynch and RBC Capital Markets forecast the second-lowest annual volume since 2008, and issuance is down almost 17 percent from 2012.
Predictions that supply will ebb may bolster confidence in munis’ performance this quarter. Local debt has gained in the year’s final three months in seven of the past 10 years, according to Bank of America data.
Phil Fischer, head of muni research at Bank of America, and Chris Mauro, head of muni strategy at RBC, project 2013 issuance at $325 billion to $330 billion. That would be the second-smallest total in the past five years and down from $352 billion in 2012.
Sales slowed this year as refinancing proved less economical after interest rates rose from generational lows. Benchmark 10-year yields are about 2.75 percent, compared with as little as 1.52 percent in December, Bloomberg data show.
For investors, the debt shortage has helped offset the biggest annual losses in munis since 2008. Individuals have withdrawn $55 billion from mutual funds focused on local debt in the past 21 weeks, the most ever, Lipper US Fund Flows data show.
City and state debt has weakened more than other fixed-income assets. Munis lost 3.2 percent this year through Oct. 22, compared with declines of 1.9 percent for Treasuries and 1 percent for company securities, Bank of America data show.
“There is no doubt that issuance was adversely impacted by rising interest rates and the dismal market condition since late May,” Fischer, who’s based in New York, wrote in an Oct. 4 report. He predicted about $81 billion of bond sales this quarter, which would be the smallest for the period since 2008, Bloomberg data show.
The federal shutdown that began Oct. 1 temporarily dropped municipal borrowing to the least in two years. Localities had to consider whether lawmakers would fail to strike a deal in time to prevent the U.S. from defaulting, a situation the Treasury Department said may have had catastrophic consequences.
Congress agreed on a solution on Oct. 16, before the U.S. missed any payments. Ten-year Treasury yields have declined 0.23 percentage point since Oct. 15, compared with a 0.03 percentage point drop in interest rates on benchmark munis.
“The Treasury market has improved dramatically and we haven’t kept up,” RBC’s Mauro, who’s based in New York, said in an interview. “That’s solely a function of what’s happening on the supply side of our market.”
Since the resolution, issuers have returned to the market to borrow, led by California’s $2.3 billion sale this week.
State Treasurer Bill Lockyer said in an Oct. 22 interview on Bloomberg Television’s “Bottom Line” with Mark Crumpton that the state is “finding that the demand is holding up” for its general obligations.
Investors will have fewer options next week, when supply is poised to drop to $3.2 billion, the least for a non-holiday period since August 2012.
Fischer said the debt-ceiling solution and the ensuing gains in Treasuries should lead to a “resumption of the rally” in munis that started in September, before the U.S. shutdown.
“We don’t have overwhelming investor demand, so supply takes a little longer to be absorbed,” Fischer said. “If you get a rally in Treasuries, munis are likely to follow, but lag.”
Following is a pending sale:
Arkansas plans to sell $200 million of general obligations on Oct. 29 via competitive sale. Proceeds will finance work on interstate highways. Arkansas last month issued about $469 million to finance highway construction, the state’s biggest municipal offering since at least 1990.
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