A Perfect Storm
- Tuesday, 12/18/2012
For all the professionals who embraced the strong market performance of municipal bonds year-to-date, I attribute the sudden break in the positive trend to the confluence of the following events leading to what could be called a "muni perfect storm":
- Despite the continued strong inflows of cash, the recent surge in new issue supply overwhelmed dealers who appear to be paring back their inventory for the yearend.
- Aggressive selling of several hundred million (par value) of tobacco settlement bonds pressured traders early last week.
- Thursday's downgrade of Puerto Rico muni debt by Moody's to just one notch above high-yield status triggered a wave of selling and pushed prices generally lower (yields higher).
- Lack of clarity surrounding the Washington debate over the fiscal cliff has left observers fearing that, one way or the other, the tax-free coupons of municipal bonds are likely in jeopardy.
Munis gave up more ground again on Monday as more selling emerged from a cross section of investment portfolios. (See graph below.) Some seemed intent on off-loading more Puerto Rico issues, while others appear to have used the current market weakness as an excuse to step aside while the "compromise dance" continues on in Washington. Several well-known strategists have furthered the notion that the benefit from the tax-free coupon of municipals may either disappear or be aggregated into a "cap" on certain deductions (28% being the line that has been drawn in the sand). I see little likelihood that prior ownership and income will be grandfathered through new legislation, because the cash needs are dire and the result of capping only new issuance would likely result in insufficient tax revenue in the near term.
Municipal Bids-Wanted Hit Highest Level Since January 2011*
Simple Moving Average
Source: Bloomberg. The J.P. Morgan MBWDPAR Index represents the total dollar amount of wanted items on Bloomberg's buyside bids wanted system.
*Bid Wanted is the process by which an investor or broker-dealer actively solicits bids on a position of securities from the marketplace.