Municipal Market Update:
Opportunities May Appear
October 16, 2009
By Gary Gildersleeve
Partner & Fixed Income Portfolio Manager
The landscape in the municipal market changed dramatically in early October. Tax exempt bond yields spiked upward following a nearly 4 month period of slowly rising prices and declining yields. The result should be more new issues that are priced to sell between now and year-end with greater opportunities to pick up attractively priced bonds in the secondary market.
Municipal bond yields dropped dramatically from June 11 through October 5, reaching historic lows. The declines were 71, 80, and 96 bps for 5, 10, and 20 year maturities, respectively (based on the MMD AAA curve). Credit spreads also tightened during this period. The causes were strong summertime reinvestment demand (from calls, maturities, and interest payments) , investors transferring assets from low yielding cash vehicles into longer term bonds and bond funds, and reduced supply of tax exempt municipals due to the success of the taxable Build America Bond program.
Municipal bond yields retraced much of their 4 month decline during the seven trading days starting October 6. Rates for high grade securities maturing between 6 to 10 years rose approximately 50 bps (based on the MMD AAA curve), while yields on lower investment grade issues rose even more. The primary causes were unwillingness on the part of dealers to add bonds to already bloated inventories and "rate shock" by individual investors reluctant to invest with rates at historic lows. Also contributing was the fear of significant new supply between now and year end as issuers rush to market to take advantage of the historically low municipal yields.
New issue municipal supply is anticipated to increase between now and year-end, although the recent rise in rates may postpone or eliminate many refunding deals. Simultaneously, many municipal bond dealers are anxious to protect this year's record trading profits and will be reluctant to stock additional inventory. While the overall direction of the market will be influenced by any major moves in U S Treasury yields between now and year-end, we expect to see more attractively priced deals over the balance of the year, especially in the 5 to 15 year range.
We remain focused on high coupon securities priced to shorter calls and research driven, short duration securities to pick-up yield. Further, we believe selective opportunities will appear among intermediate maturities, especially for those investors with cash or very liquid high grade securities that can be sold to pick up yield. We will continue to pursue geographic diversification and avoid the general obligation and appropriation debt of most states and cities in favor of essential purpose revenue and dedicated tax bonds with stable, predictable finances and less potential exposure to rising pension obligations.
Gary Gildersleeve joined Evercore Wealth Management as a founding partner in 2008 with over 33 years of experience in managing fixed income investment strategies for high-net-worth individuals.
Municipal Market Update: Opportunities May Appear (Word Document)
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