With his remarks at last week’s Congressional hearings, Federal Reserve Chairman Ben Bernanke finally accomplished what he could not back in June: convince global financial markets that tapering is not the same as tightening and that any tapering will be completely data-dependent.
For now, the data are coming in on the softer side, as evidenced by an unexpected drop in June existing home sales. The Q2 corporate earnings season has been something of a disappointment, although many of the underperforming companies are ones with commodity-driven businesses, now that the so-called “commodity supercycle” has slowed down and the Chinese economy has decelerated.
The relentless media coverage about Detroit’s bankruptcy might further hurt fund flows this week.
All these factors have combined to give a positive skew to the Treasury market, sending 10- year Treasury yields to the lowest level in almost three weeks, at 2.46%. A key measure of Treasury market volatility, the MOVE Index, has also settled down at 73, after peaking at about 118 on July 5th. It would appear that a September Fed tapering scenario has been fully discounted by a 2.50% or so ten year Treasury yield.
The government bond market’s more constructive tone failed to extend to the tax-exempt market, unfortunately. After moving sideways for much of last week, municipals finally gave up the ghost on Friday and sold off by 11 basis points, according to Municipal Market Data (MMD). You can blame it on a lack of demand, as evidenced by massive mutual fund outflows. The relentless media coverage about Detroit’s bankruptcy might further hurt fund flows this week. As a result, yield levels for longer maturities are now re-testing the highs reached in the depths of the June meltdown. The belly of the curve has performed better, benefiting from investor reluctance to take on too much duration risk.
Of course, the combination of a stronger Treasury market and an underperforming muni market is always a nightmare combination for most dealer desks: they end up losing money on both their cash muni holdings and on the Treasury bonds they use to “hedge” their inventory.
New Issue Market
Thus it’s no surprise the municipal market was off to a slow start this week, as market participants try to divine the potential impact of the Detroit bankruptcy on investor demand. The new issue calendar has dwindled to about $5 billion, including yet another transportation mega-issue, a $750 million offering from the Bay Area Toll Authority, CA (BART). Also on the negotiated docket: $375 million New York City G.O.s and $300 million District of Columbia Water & Sewer Authority. The competitive calendar will feature G.O. deals from a sterling State credit, the State of Maryland ($475 million), and the not-so sterling State of Connecticut ($200 million).
Given the uncertain outlook, we would expect the new deals to be priced to move, which may create yet another downdraft in the secondary.
The Latest on Detroit
Needless to say, the Detroit bankruptcy has been a boon to both the traditional news outlets as well as the social media such as Twitter. And this is only the beginning. Over the next few months, we will all be bombarded with opinions, half-truths and political posturing of all persuasions. Through this column, we will try to filter out all the noise and report to you only those items that we, as muni professionals, find significant.
One of the general tendencies of the media is to extrapolate a seminal credit event like Detroit into a “trend.” Already, other fiscally-stressed cities as Chicago have been mentioned in the same breath as Motor City. Nothing could be further from the truth. Most muni professionals would view Detroit as a unique, idiosyncratic situation and we share that opinion. That said, the city’s Chapter 9 filing does raise some key credit issues that have been troubling our market for some time, including pension and OPEB funding and the role of municipal employee unions, both very politically-charged topics. Over the next few weeks, as the Detroit case unfolds, we will have an opportunity to examine each of these factors in more details.
One of the first rules of credit investing is that you should never have to test your legal covenants and security package. Once you get into a bankruptcy situation, regardless of how strong you think your security provisions are, all bets are off. The Detroit situation shows there is no longer any legal sacred cow.
As for the latest news, late yesterday, Emergency Manager Kevyn Orr was successful in getting approval from the bankruptcy judge for an expedited hearing on City’s Chapter 9 eligibility. The hearing is scheduled for tomorrow, July 24th.
Puerto Rico Update
Lost in all the commotion created by Detroit last week was a news item we found rather disturbing. The president of Puerto Rico’s Government Development Bank (GDB), Javier Ferrer, resigned after only seven months on the job. As readers of this column may recall, we’ve expressed concern about the Bank’s precarious financial status, particularly through the loans it has made to the Highway Authority. Although the PR legislature has recently acted to direct more tax revenues toward the Authority, the GDB remains the weak link in the Commonwealth’s financial structure. A change of leadership at this critical juncture, reportedly as a result of policy disagreements, would be an unwelcome development. Current Treasurer Melba Acosta has been mentioned as a potential successor to Mr. Ferrer, which we would view as a positive move, although her departure might leave a big void at Treasury.
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