August Rally Signaled by Record Cash Wave Spillover: Muni Credit

August Rally Signaled by Record Cash Wave Spillover
Washington state and Monroe Township, New Jersey, are among issuers planning to refinance higher-cost debt next month. Photographer: Andrew Harrer/Bloomberg

The $3.7 trillion municipal market is wrapping up its best month since January. If the past decade is any indication, August may be even better.

Munis have earned 1.5 percent on average in August since 2001, the most for any month, Bank of America Merrill Lynch indexes show. Local debt has gained about 1.8 percent this month through July 26. Helping propel the gains, about $142 billion flowed to bondholders from redemptions and refinancing since May, the most ever for a three-month period, according to Citigroup Inc.

The fund surge may spill over to the next four weeks after localities issued $25 billion of debt in July, the least since February, data compiled by Bloomberg show. The slowdown shows no sign of a letup during the U.S. summer months. It is leaving bondholders with uninvested money amid a 2012 fixed-income rally fueled partly by concern the global economy is slowing.

“Bond funds are sitting on a huge pile of cash that remains to be invested,” said Vikram Rai, a muni strategist at Citigroup in New York. “The flight-to-safety bid has been very strong, and that has served munis well.”

The tax-exempt market enters August with interest rates close to the lowest in more than four decades. Twenty-year general-obligations yielded 3.61 percent last week, according to a Bond Buyer weekly index. Aside from a 3.60 percent reading earlier this year, it hasn’t been lower since 1967.

Cost Boon

Tumbling borrowing costs are a boon to municipalities struggling to restore their finances three years after the nation emerged from the longest recession since the 1930s. Of the $206 billion of municipal offerings this year through July 18, about 63 percent has been for refunding, Bank of America data show. Washington state and Monroe Township, New Jersey, are among issuers planning to refinance higher-cost debt next month.

Issuance is still set to be below the 2012 average. Municipalities have $6.7 billion of sales scheduled, according to the Bloomberg 30-Day Visible Supply index, about 26 percent below the average this year.

“Historically the summer months are a fight to get paper, and that positive demand dynamic takes you right through into September,” said John Dillon, chief muni strategist in Purchase, New York, at Morgan Stanley Smith Barney, which manages more than $150 billion in state and local debt. “You’re still going to have July money being put to work in August. You’re still going to have robust municipal fund inflows.”

Beating Treasuries

With defaults on the decline and state finances improving, munis have been a haven from Europe’s debt crisis and signs the U.S. rebound is cooling. The world’s biggest economy grew at a 1.5 percent annual rate last quarter after a 2 percent gain the prior three months, Commerce Department figures showed last week.

Local debt has returned 5.9 percent this year through July 26, the best start since 2009, and beating a 3.1 percent advance by Treasuries, Bank of America data show.

Forty-two municipal issuers have defaulted for the first time this year through July 24, down from an average of 76 in the same period the past two years, according to Municipal Market Advisors. Yields have dropped even as three California localities decided to seek bankruptcy protection since June.

Tax-free yields haven’t declined as quickly as those on Treasuries, which fell to record levels this month. Yields on tax-exempts due in 10 years have exceeded their federal counterparts since mid-May, the longest span since 2009. The elevated ratio means munis are cheaper than Treasuries.

Balancing Out

“The ratio offers a counterbalance against the absolute-low yield levels we’ve been contending with,” Dillon said.

Municipal mutual funds have added $18 billion this year through July 25, the most for the period since 2009, Lipper US Fund Flows data show.

Muni-debt sales are poised to exceed bond calls and refundings by $12.3 billion in August, the most since December 2010, after a negative $6.2 billion in July, according to Citigroup. In the last three months, investors were faced with “net negative supply” as bond sales trailed the money received from redemptions and refunding.

“We’re not going to see a large back-up in yields just because we have positive bond supply,” said Rai.

Following are pending sales:

DORMITORY AUTHORITY OF THE STATE OF NEW YORK plans to offer $250 million of taxable bonds as soon as Aug. 2. The debt will be sold for the New York University Hospitals Center. Moody’s Investors Service rates the securities A3, seventh-highest. (Added July 30).

New York’s TRIBOROUGH BRIDGE & TUNNEL AUTHORITY plans to sell about $1.2 billion of revenue bonds as early as this week, according to an offering statement. Proceeds will be used to refund debt. (Added July 30).

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