Long-Bond Gains Seen Short-Lived as Fed Taper Nears: Muni Credit
The biggest rally in 30-year state and local debt since June may be fleeting amid signs the Federal Reserve will begin cutting back its bond purchases, leading to higher interest rates.
Investors this week demanded as little as 1.24 percentage points of extra yield to own municipal securities maturing in 2043 rather than those due in a decade, data compiled by Bloomberg show. That was the least in five months. Longer bonds typically offer higher yields to compensate for the added risk of the lengthier holding period, though the gap fluctuates according to the outlook for inflation and interest rates.
Long-term munis have earned about 0.6 percent in the past month, compared with 0.3 percent for the shortest maturities, Standard & Poor’s data show. The outsize gain gives individuals a chance to shorten maturities as bets mounts that the Fed will curb its bond buying, said John Dillon at Morgan Stanley Wealth Management. For issuers such as Florida’s Sarasota County, it’s an opportunity to lock in lower borrowing costs for decades.
“Rates are more likely to rise than fall in the near future, and that’s what hinders me from saying go out all the way on the end of the curve,” said Dillon, the company’s head of muni strategy in Purchase, New York. “You’re not getting paid to do so, and interest rates won’t be in your favor.”
This wouldn’t be the first time this year for munis to be undermined by bets on the Fed’s plans. Yields set a two-year high in June after Fed Chairman Ben S. Bernanke’s comments that the central bank would slow its buying in 2013 if the economy continued to improve. He unexpectedly decided in September to refrain from curbing the purchases.
Even with this month’s muni earnings, the mid-year yield leap leaves the $3.7 trillion market poised for its first annual loss since 2008, joining declines in Treasuries and company debt.
Long bonds have still been the worst place for muni investors in 2013, losing 1.5 percent while the shortest maturities have gained 1 percent, S&P data show.
Investors have been watching the central bank’s policy decisions for guidance on interest rates.
Fed officials may reduce their $85 billion in monthly purchases of Treasuries and mortgage debt “in coming months” as the economy improves, according to minutes of their last meeting released this week. The minutes also show discussion on how to increase the clarity of their plans to hold their target for the benchmark overnight interest rate near zero.
If the Fed keeps the overnight rate where it is, the “front end fits the bill,” Bill Gross, manager of the world’s biggest bond fund at Pacific Investment Management Co. in Newport Beach, California, wrote yesterday in a message on Twitter.
The central bank probably won’t taper bond purchases until March, according to the median of 32 economist estimates in a Nov. 8 Bloomberg survey.
It would be the first time since 2008 that short-term securities have beaten their longer-maturity counterparts, S&P data show.
“The demand for short paper has been extraordinary,” said Jim Grabovac, senior portfolio manager at Oak Brook, Illinois-based McDonnell Investment Management, which oversees about $8.5 billion in munis. “The investor preference is to get out of the long end and stay short.”
Benchmark 30-year muni yields ended October at 4.33 percent and were at 4.16 percent yesterday, Bloomberg data show. They started the year at about 2.76 percent. This month’s drop offers local issuers a shot at reduced borrowing costs.
Sarasota County on Florida’s west coast plans to offer in bonds on Dec. 3 to acquire Dolomite Utilities Corp., a water and sewage system that distributes to 9,000 people in the locality. The longest-maturing portion of the deal is due in October 2043.
George MacFarlane, manager of business operations for the county’s public utilities, said in an interview that the decline in 30-year yields in the past month was a “nice surprise” after interest rates rose earlier in the year.
The municipality is borrowing amid outflows from long-term muni mutual funds. Individuals have added assets to the funds in only one of the past 38 weeks, Lipper US Fund Flows data show.
“Investors are voting with their feet -- they’re concerned about where rates are going to go,” Morgan Stanley’s Dillon said. “If you look further out on the curve, you really see the law of diminishing returns.”
Issuers from New York to Arizona are set to offer about $1.3 billion in long-term debt next week, after selling about $7.8 billion this week, Bloomberg data show. The market is closed Nov. 28 for the U.S. Thanksgiving holiday.
The ratio of the yields, a gauge of relative value, is about 102 percent. It compares with an average of 94 percent since 2001. The smaller the number, the more expensive munis are compared with federal securities.
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