Munis Weaker Despite Treasury Gains

The tax-exempt market ended Tuesday weaker, continuing a sell-off that began Friday after almost three weeks of gains.

Despite a three-day holiday weekend, municipal bond traders said the market got off to a busy start as it made up for lost time.

“I noticed a few bonds in our inventory did cheapen up about 10 basis points since last week,” a New Jersey trader said. “From what I could see here and there, they are weaker.”

Other traders agreed. “There is a little bit of activity,” a New York trader said. “People are cutting bonds and hitting some bids.”

The competitive calendar took the lead Tuesday. California’s Fontana Unified School District auctioned $299.1 million of general obligation bonds in two pricings — a $78.12 million deal and $220.93 million deal. The bonds are rated Aa3 by Moody’s Investors Service.

Raymond James | Morgan Keegan won the bid for $78.12 million of general obligation refunding bonds. The bonds had coupons ranging from 2% in 2013 to 3.25% in 2031. Yields were not formally re-offered. The bonds are callable at par in 2022.

Citi won the bid for $220.93 of capital appreciation bonds. The zero-coupon bonds had yields ranging from 5.00% in 2030 to 5.75% in 2044.

Bank of America Merrill Lynch won the bid for $120 million of Milwaukee school revenue anticipation notes, rated MIG-1 by Moody’s and SP-1-plus by Standard & Poor’s. The bonds yielded 0.19% with a 1.5% coupon in 2013.

In the secondary market, trades compiled by data provider Markit showed a mix of strengthening and weakening.

Yields on Massachusetts 5.25s of 2023 jumped three basis points to 2.03% while Ohio’s Buckeye Tobacco Settlement Financing Authority 5.75s of 2034 increased one basis point to 7.60%.

Other trades showed strengthening. Yields on Connecticut State Health and Educational Facilities Authority 5s of 2040 and New York 3.25s of 2035 fell three basis points each to 2.05% and 3.32%, respectively. Yields on New Jersey State Transportation Trust Fund Authority 5.5s of 2041 fell two basis points to 3.28%.

On Tuesday, the 10-year Municipal Market Data yield and the 30-year yield rose one basis point each to 1.70% and 2.87%, respectively. The two-year closed flat for the 10th session at 0.30%.

The 10-year yield now trades 10 basis points above its record low of 1.60% set July 26. The 30-year yield is up eight basis points above is record low of 2.79% hit July 25.

The Treasury yield curve flattened as yields on the short end rose and yields on the long end fell. The two-year yield rose one basis point to 0.27%. The benchmark 10-year yield fell one basis point to 1.72% while the 30-year yield dropped three basis points to 2.93%.

Over the course of October, muni-to-Treasury ratios fell as munis outperformed their taxable counterparts and became relatively more expensive. The five-year muni yield to Treasury yield ratio fell to 94% on Tuesday from 100% on Oct. 1. The 10-year ratio slipped to 98.8% from 104.9% at the beginning of the month. The 30-year ratio dropped to 98% from 101.1%.

Over the course of the year, ratios on the short- and long-end have fallen while ratios in the belly of the curve have risen and the market underperformed taxables. The five-year ratio fell to 94% on Tuesday from 98.9% at the beginning of the year while the 30-year ratio dipped to 98% from 119.4%. But, the 10-year ratio increased to 98.8% from 96.4%.

Credit spreads have continued to compress, despite recent weakening, as yields remain near record low levels.

The five-year triple-A to single-A rated spread compressed to 57 basis points on Tuesday from 58 basis points at the beginning of October. It has compressed 25 basis points from 82 basis points at the beginning of the year.

The 10-year spread also compressed to 73 basis points from 74 basis points at the start of the month. It has fallen a whopping 33 basis points from where it began the year at 96 basis points.

The 30-year spread held steady at 73 basis points throughout the month but has fallen 16 basis points from the beginning of 2012 where it started at 89 basis points.

To be sure, the slope of the yield curve has steepened throughout October as yields on the long end have started to sell off and investors shorten the duration of their bonds.

The one-to 30-year slope of the curve rose to 267 basis points on Tuesday from 265 basis points at the beginning of the month. But the slope is still much flatter from the 332 basis points it started at in the beginning of the year.

The 10- to 30-year slope also steepened to 117 basis points from 115 basis points at the beginning of the month. The slope is still very flat from the 169 basis points where it started in the beginning of January.

While munis have weakened over the past two sessions, the rally throughout most of October helped Standard & Poor’s Dow Jones Indices mutual funds to post gains. The S&P National AMT-Free Municipal Bond Index returned 0.04% month to date and 6.30% year to date while the S&P Municipal High Yield Index has returned 0.25% so far this month and 14.49% year-to-date.

High-yield sectors continue to outperform the market. The S&P Municipal Bond Tobacco Index returned 0.80% month-to-date and a whopping 17.55% year-to-date. The S&P Municipal Bond Land Backed Index returned 0.06% so far this month and 10.35% so far this year. Similarly, the S&P Municipal Bond Health Care Index returned 0.16% in October through Tuesday and 9.67% so far this year.

State specific indices that are outperforming the general market include Ohio which has returned 0.28% this month and 8.24% year-to-date. New Jersey has returned 0.15% this month and 7.66% this year.

Similarly, California has returned 0.09% so far in October and 7.83% so far this year. Illinois has returned 0.08% this month and 8.07% so far this year while Colorado has returned 0.07% through October and 8.12% through the year.

Michigan — which had one of the worst state economic readings last week by the Philadelphia Federal Reserve Bank — returned 0.15% so far in October and 7.24% so far this year.