Munis Gear Up for the Rest of 2012

Municipals marked a day of rest following a torrid week of buying and record-setting yields.
While the bond markets were closed to observe Veterans Day, industry watchers said they were optimistic about investor demand and the overall state of the market.
Muni issuance, low for the season the past two weeks as issuers and underwriters returned to relatively normal operations following Hurricane Sandy, is expected to rebound to a moderate level in the holiday-shortened week.
Tax-exempt yields broke records in consecutive trading sessions last week at the 10- and 30-year parts of the curve, Municipal Market Data numbers showed. The benchmark 10-year AAA yield plunged to a record low 1.57%. The 30-year dropped to an all-time low of 2.66%. The two-year ended the week unchanged at 0.30% for the 32nd straight trading session.
For their part, Treasury yields ended Friday where they started. The benchmark 10-year yield and the 30-year yield held fast at 1.62% and 2.76%, respectively. The two-year was unchanged at 0.26%.
Though frustrating for bond buyers, the extremely low rates should not be perceived as a threat to the market's health, given how the economy has been showing signs of recovery, said Chris Mier, a managing director at Loop Capital Markets.
"The market should make less of the fear factor for where the 10-year AAA and the 10-year Treasury are priced," he said. "From a fundamental standpoint, rates should be a little higher. But rates will likely stay a little higher than where they are for the remainder of the year."
The conclusion to last week's elections in the U.S. had some implications for the tax-exempt market. For one, the risk of the possible capping of the municipal tax exemption at the 28% tax bracket level should loom over the market well into next year, John Dillon, managing director at Morgan Stanley Wealth Management, wrote in a research report. Still, he added, munis should see a boost from the potential for higher marginal tax rates for individual and married taxpayers with adjusted gross incomes above a certain threshold, a group that accounts for roughly half of the muni buyer base.
"In fact, if weighed against each other, we suspect that the prospects of a compromise that allows tax rates to rise … for this group of investors outweighs the probability of capping the value of the municipal exemption," Dillon wrote. "Such a development would be generally constructive with regard to demand for tax-exempt paper."
Those factors may lead to a slight bias for an issuer to bring a deal to market this year rather than in 2013, Loop's Mier said. All told, he added, the market should not see any real fall-off in issuance over the remainder of 2012.
"The market has a very strong demand side," Mier said. "The deals have consequently been doing very well; they've been placed well. There's no immediate threat to that. Demand isn't moving into other asset classes."
Muni issuance is picking up from storm-induced lows. Estimated volume for this week should total $7.61 billion, up from $4.65 billion last week. JPMorgan should arrive with the week's largest negotiated deal when it prices $853 million in Texas Transportation Commission Central Texas Turnpike System revenue refunding and put bonds in two series on Thursday.
Muni ratios to Treasuries have gotten richer at the 10-year and 30-year marks for most of October and November, MMD numbers showed. The 10-year sits at 97.5%, beneath its average for the period of 99.5%. The 30-year ratio resides at 96.7%, below its average of 97.9% for the period. The two year, rarely under 100% during the span, has averaged 108.8%; it sits at 111.1%.