Morgan Stanley Sees Sales Surge Fueling Worst Month: Muni Credit
The $3.7 trillion municipal-bond market is heading for its worst monthly performance since June. If the past decade is any guide, October may be even worse.
Munis on average have lost 0.41 percent in October since 2001, the biggest decline for any month, Bank of America Merrill Lynch indexes show. This month, local-government bonds have gained about 0.21 percent, the least since they lost 0.07 percent in June.
With muni mutual funds adding the fewest assets since April and localities issuing the most debt in three months, that trend is poised to continue, said John Dillon, chief municipal-bond strategist at Morgan Stanley Smith Barney in Purchase, New York. States and cities that end their fiscal years June 30 tend to wait a few months before coming to market, which may account for the sales surge, he said.
“We are on the tail end of robust demand, and we are at the front end of a step-up in supply,” said Dillon, whose company oversees more than $150 billion in local debt. “There’s this supply-demand imbalance that’s opposite what you had in June, July and August. It’s a seasonal trend reversal.”
The tax-exempt market has returned 6.2 percent this year as investors sought a haven from Europe’s debt crisis. The gain is more than triple that of Treasuries, which have returned 2 percent, Bank of America data show. That’s the biggest differential for the period since 2009.
In the three months beginning July 1, the muni market has returned about 2 percent, the data show. That’s the seventh- straight quarter of gains, the longest stretch since 2001.
The rally is poised to pause in October, the month with the most local-government sales for the past three years, data compiled by Bloomberg show. The New York State Dormitory Authority and Kansas State Department of Transportation are among issuers planning deals next month, Bloomberg data show.
The jump in supply caused yields on top-rated general- obligation bonds, which move inversely to prices, to rise in eight of the past 10 Octobers, Bloomberg data show. Such predictable patterns cause buyers to wait to invest, said Peter Hayes, head of muni bonds at New York-based BlackRock Inc., the world’s biggest money manager.
“If you look historically at price performance in October, you can see the market exhibits some seasonal weakness,” said Hayes, whose company oversees about $106 billion of munis. “If you have cash and bonds coming due, you just sit on it a little bit longer and wait for the market to adjust.”
That mindset may be behind the slowing of cash flowing into municipal-bond mutual funds. They added about $256 million in assets during the week ended Sept. 19, the fewest since April, Lipper US Fund Flows data show. Inflows this year total $23 billion, the most since 2009.
The drop in demand comes as issuers are selling $9.3 billion this week, the most in three months, Bloomberg data show. In the week ended Sept. 21, municipalities issued $9.1 billion of debt.
Municipalities have sold about $257.5 billion in debt this year, close to the $258 billion issued in all of 2011, Bloomberg data show. About 51 percent has been to retire previously issued debt, which has helped create “net negative” supply, or when cash to investors from redemptions and refunding exceeds sales.
That phenomenon will reverse in September and October, when new debt may exceed maturing securities and bond calls by about $27 billion, the most for a two-month period since December 2010, according to Citigroup Inc. data.
The U.S. presidential election and potential changes to the municipal-bond tax exemption may heighten the trend of localities issuing debt next month, Dillon said. In October 2010, three months before the expiration of the Build America Bonds program, states and cities sold $54 billion, the most since at least 2003 and more than any month since.
Muni yields heading into October are hovering near record lows. The interest rate on 10-year benchmark AAA munis was 1.76 percent yesterday. It fell to 1.63 percent on July 27, the lowest since at least January 2009, Bloomberg data show.
Last year, the interest rate plunged 0.62 percentage point in November and December, sending rates near the lowest since Lyndon Johnson was president.
“Yields have fallen awfully far and awfully fast,” Hayes said. “Any time they rise, it does create a better opportunity, and that’s what we’re looking forward to.”
Following are pending sales:
MINNESOTA OFFICE OF HIGHER EDUCATION is set to issue $375 million of revenue debt as soon as next week, according to the preliminary official statement. Standard & Poor’s rates the bonds AA-, fourth-highest. (Added Sept. 27)
NORTH TEXAS TOLLWAY AUTHORITY plans to sell about $136 million in revenue bonds as soon as next week for refunding, according to an offering document. Moody’s Investors Service rates the debt A2, sixth-highest. (Added Sept. 27)
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