Cash Spurs Muni Rally at 2014 Midpoint After Worst MonthElizabeth Campbell and Brian Chappatta
Municipal-debt investors are betting the year’s biggest increase in yields will prove a temporary setback as a wave of cash returning to bondholders revives the strongest start to a year since 2009.
State and local debt climbed 6.5 percent this year through June 26, beating Treasuries and corporate bonds, Bank of America Merrill Lynch data show. Though muni yields in June rose 0.12 percentage point, the most this year, the rally is showing signs of resuming as higher rates entice investors, said John Flahive at BNY Mellon Wealth Management and Chad Farrington at Columbia Management Investment Advisors.
Munis are outpacing other fixed-income assets because of an imbalance between increased buyer demand for tax-free interest and the reluctance of localities to issue new debt. That trend may intensify in July and August, when sales typically slow, as investors receive the most cash from debt payments since 2012, according to Peter DeGroot at JPMorgan Chase & Co.
“If you want to buy bonds, you better buy them now,” said Flahive, the Boston-based director of fixed income for BNY Mellon, which oversees $22 billion in munis.
“I don’t think we’re going to have enough acceleration of supply, and demand is going to be relatively stable to strong,” he said. “Munis have the potential to continue to outperform.”
Benchmark 10-year muni yields last week reached 2.42 percent, a two-month high, after localities bucked this year’s austerity trend to sell $24 billion of debt in the three weeks through June 20. That was the most since April 2013, according to data compiled by Bloomberg.
Interest rates then dropped by the most in a month as investors anticipated a bond shortage. States and cities have set $3.8 billion of debt sales over the next 30 days, the least since February and below the 2014 average of $6.8 billion, Bloomberg data show.
The supply slowdown falls in line with history’s guide. Municipalities issue an average of $32.5 billion in June, the most of any month, according to Bloomberg data that starts in 2003. Bond sales fall to $24.8 billion in July and $25.3 billion in August, the fourth- and fifth-lowest months of offerings, the data show.
The declining issuance also coincides with a period in which current bondholders get a wave of cash back from interest and principal payments. That creates inherent demand for munis, assuming investors want to continue owning state and local debt.
The bond payments, along with cash from refinancing debt, will exceed issuance in June, July and August by a combined $23 billion, the most since 2012, according to DeGroot, head of municipal research in New York at JPMorgan. The peak will occur in the next two months, he said.
“We’re in the seasonal period where you get a lot more money chasing few bonds -- that’s in place at least over the next few months,” said Farrington, head of muni research in Boston at Columbia Management, which oversees about $30 billion in local debt.
Individuals have added assets to muni mutual funds in 20 of the first 25 weeks this year, including $234 million in the week ending June 25, Lipper US Fund Flows data show. That’s a reversal of last year, when Detroit’s bankruptcy and concerns that Puerto Rico’s economic decline would leave it unable to pay bondholders spurred record withdrawals.
Investors also yanked money from funds in 2013 on bets that interest rates would keep rising as the Federal Reserve trimmed its bond-buying program. Morgan Stanley and Barclays Plc were among those forecasting a second year of losses in 2014 as yields climbed.
“At the beginning of the year, munis were way too cheap,” John Miller, co-head of fixed income at Nuveen Asset Management, which oversees $92 billion of munis, said in an interview in the firm’s Chicago office. Even after the rally, he said, “retail, insurance companies and banks, they’re still buying.”
While benchmark 10-year muni yields have fallen about 0.55 percentage point this year, outpacing the 0.5 percentage point drop in similar Treasuries, the forecasts of higher borrowing costs in the future remain.
Yields on 10-year Treasuries will climb about 0.67 percentage point to 3.2 percent by the first quarter of 2015, according to the median forecast of 72 analysts in a Bloomberg survey. That projection is down from 3.58 percent in January.
“The big fear was losing a lot of money with major interest-rate increases,” Miller said. “That is abating” as people see yields fall this year, he said.
Tax-exempt borrowings are luring individuals because in April some faced levies on bond interest payments as much as 24 percent higher than in 2012. Ten-year muni yields are equivalent to 4.19 percent on a taxable basis, compared with 2.53 percent for Treasuries.
“You look across the different markets and, relatively speaking, municipals are very attractive,” Farrington said. “That lead us to believe that while we’re not expecting to see a repeat of what we saw in the first half, we don’t see a reversal.”