The global flight from risk continued to bolster the municipal bond market on Wednesday as the prospect of a nuclear meltdown in Japan enhanced the appeal of the shelter of low-risk bonds.
The dumping of risky assets in favor of Treasury debt accelerated Wednesday as the news out of Japan appeared starker.
The 10-year Treasury yield plunged 12 basis points to 3.21%, the lowest yield of 2011. The S&P 500 sank 1.9%, and the Chicago Board Options Exchange’s measure of volatility, known as the VIX, spiked 18.6%.
Flights from risk like this one are usually supportive of municipal bonds, thanks to their demonstrable correlation with Treasuries over time, generally low credit risk, and denomination in dollars — a decided safe-haven currency.
The 10-year triple-A municipal yield shed three basis points to 2.9% after dropping seven basis points the day before, based on the Municipal Market Data scale. The entire MMD yield curve has strengthened the past two days, by a convincing 10 basis points for most maturities 10 years and out.
The 10-year yield is at its lowest level since early December.
“With the stock market running down, people have money and they don’t know where to put it,” a trader in Chicago said. “We’re seeing some interest. It hasn’t been robust, but it’s been steady.”
Evidence of the municipal market’s strength could be detected in the secondary market trading of Maryland’s $485 million deal that priced last week with unsold balances. The 2026 maturity of that deal changed hands Wednesday at a yield of 3.6%, a solid 15 basis points lower than a similar type of transaction a day earlier.
Boston’s Big deal
Yesterday’s big offering in the primary market was Boston, which is only the latest high-grade issuer to bring a mid-sized bond sale to market during a supply drought.
Maryland, the Georgia Road and Tollway Authority, Portland, Ore., Connecticut, and Wake County, N.C., have all found willing buyers in the current environment the last two weeks.
While not all the pricing for Boston’s $181.5 million deal was available by press time, early indications were the city, whose credit is very well-regarded, commanded strong bids.
Jefferies & Co. was the winning bidder on a $14.4 million piece of the deal in the competitive market. A five-year maturity priced at a yield of 1.68%, just about in line with the triple-A scale. Bank of America Merrill Lynch was the winning bidder on most of the deal’s components.
Piercing the Veil
Temporary panic trades notwithstanding, the municipal bond market remains shrouded in fog.
Municipalities have floated just $37.5 billion of debt so far this year, according to Thomson Reuters, and are well on their way to their lightest quarterly issuance since 2000. The bulk of deals coming to market are bite-sized and highly rated, in many cases triple-A.
One banker said that with fiscal austerity all the rage and issuers still working through budget season, there’s no reason many municipalities can’t hold off on borrowing until the second half of the year.
Normally, true price discovery requires some tension, which typically comes in the form of supply. New bonds force dealers to move inventory, illuminating the state of demand. Given the fragility that was exposed in the fourth quarter and earlier this year, the drought of new bonds casts a veil over the market. We are left to wonder what sort of prices municipal bonds would be trading at without the premium for scarcity.
Just how big is demand for tax-free debt? What is the market’s capacity for the absorption of tax-free bonds without pushing yields to distressed levels? We don’t know.
The pricing services and the yield curve scales keep coming out with their guesses, but there is widespread skepticism on the Street about how reflective these are of underlying demand.
Michael Zezas, who heads municipal research at Morgan Stanley, points to an illustrative trend: bid-wanteds constitute an exceptionally high percentage of daily trading volume.
What this tells us is that people are trying to sell bonds and not finding buyers, or at least not liking the prices that would-be buyers offer. The pricing scales therefore offer incomplete information. They can’t account for the deals that never take place because sellers didn’t find adequate demand for their paper.
“If you look at trading volumes versus bid-wanteds out there, it’s pretty clear the market is away from what the pricing services say it’s at,” Zezas said. “Without the week-to-week information that you get from pricing a series of large deals, there aren’t a lot of data points that portfolio managers can hang their hat on.”
Granted, the bid-wanteds have abated significantly since mutual funds were contending with more than $3 billion of outflows a week earlier this year. But we would actually argue price discovery during that time was better than it is now. Those were real-life arm’s-length deals between willing buyers and sellers, as opposed to the imaginary trades that inform the scales now.
A trader in New York described a disconnect between what prices the potential sellers are looking for and what prices potential buyers are willing to pay.
Bondholders are seeking bids on $725 million of munis, according to a Bloomberg LP index. The reason many of these bonds are not changing hands is that buyers and sellers are disagreeing on price by about half a cent on the dollar, the New York trader said.
“There’s still quite a bit of bids-wanted in the market right now,” the trader said. “The real issue now, though, is are they trading and what are people willing to pay for it? I know what I’m willing to pay and what people want are in two different places right now.”
So drastic is the schism between buyers and sellers that this trader said he would be “shocked” if more than 60% of the bonds submitted for bids are actually transacting right now.