Treasuries Beating Tax Exempts Longest Since May: Muni Credit
U.S. municipal bonds are poised to trail Treasuries for the longest stretch since May as localities plan the biggest wave of borrowing this year while facing federal spending cuts set to begin tomorrow.
March is historically one of the weakest months for the $3.7 trillion municipal market as investors sell to make April 15 tax payments while the pace of offerings typically rises. California and Maryland are among states and cities that have already scheduled a combined $13.3 billion of issues in the next month, the most since November, data compiled by Bloomberg show.
Treasuries may also gain more than munis as investors prepare for $85 billion of reduced U.S. government spending scheduled to occur in the remaining seven months of the fiscal year, said Gary Pollack, head of fixed-income trading at Deutsche Bank AG’s private-wealth unit in New York. Any signs of diminished economic growth from the cuts would give federal debt an outsize boost, he said. At the same time, localities relying on military spending could be hurt.
“Treasuries would probably benefit more,” said Pollack, who manages $12 billion. “Munis may follow Treasuries, but may lag. Those communities where there’s a large federal presence will certainly lag.”
Tax-exempt obligations have earned 0.3 percent this month through Feb. 26, compared with 0.6 percent for Treasuries, Bank of America Merrill Lynch data show. If history is any guide, federal bonds are set to beat munis again in March. Yields on 10-year Treasuries have risen 1 percent on average in March since 2009, while muni yields jumped 7.4 percent, data compiled by Bloomberg show.
Munis haven’t lost to Treasuries for two consecutive months since May, Bank of America data show.
While states and cities tend to increase borrowing in March, investors often sell munis or buy less as they prepare tax payments, said Ebby Gerry, who helps oversee $15 billion of munis at UBS Global Asset Management in New York.
Debt-holders are also getting less in principal and interest payments from tax-exempt debt to reinvest, according to Pollack. Investors will receive about $18 billion of redemption payments from tax-free securities in March, compared with a projected $30 billion of muni issuance, according to an RBC Capital Markets report dated Dec. 5.
“It’s a month with one of the lowest redemption and coupon payment dates, and at the same time supply picks up as we get into warmer weather and it’s better for construction,” Pollack said.
California, which received its first credit rating boost since 2006 from Standard & Poor’s last month, leads the issuance slate with $2.7 billion of general obligations set for sale the week of March 11, according to the state treasurer’s website. Maryland, with a negative outlook from Moody’s Investors Service because of its link to federal spending, plans to sell $693 million next week.
Munis are already approaching levels that lured buyers in past months.
Benchmark 10-year munis yielded 1.89 percent yesterday, close to the highest since August, according to Bloomberg Valuation data. Treasuries of the same maturity yielded about 1.9 percent after gaining this week amid a flight to safety from Europe’s debt crisis.
The ratio of the two yields, which investors use to gauge relative value, was about 100 percent yesterday, Bloomberg data show. When the figure reached a similar level in December, munis rallied versus Treasuries. The ratio has averaged about 93 percent since 2001. Munis tend to have lower yields than federal bonds because interest on state and local debt is exempt from taxation.
“You’re getting awfully close to munis being attractive relative to Treasuries,” Gerry said.
The reaction of fixed-income assets to federal spending cuts, known as sequestration, may guide investors’ assessment of relative value in coming weeks.
The reductions would total $1.2 trillion over nine years. They would be divided almost evenly between defense and non- defense spending. The plan was part of a 2011 deal to raise the U.S. debt ceiling.
Reduced military spending would affect areas dependent on such federal funds, and yields on debt of lower-rated states and cities may increase as a result, Gerry said.
Defense procurement accounts for at least 9 percent of the gross domestic product in Maryland, New Mexico and Virginia, according to Moody’s Investors Service. The three states have top ratings and negative outlooks from Moody’s because of their ties to federal spending.
“You can have credit impact with sequestration,” Gerry said. “You have to watch it from a credit perspective.”
Following is a pending sale:
TEXAS’S LOWER COLORADO RIVER AUTHORITY plans to issue $308 million of revenue bonds as soon as March 5 through competitive bid, data compiled by Bloomberg show. Proceeds will refund debt, according to bond documents. (Added Feb. 28)
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