Market Outlook
After last week’s relatively subdued activity level, the Treasury market is gearing up once again for a slew of key economic releases this week. If the recent strength of the dollar is any indication, the market is looking for much firmer economic growth in Q3 versus what turned out to be a rather lackluster Q2.
Retails sales did come out on the stronger side this morning, with a 0.2% rise reported for July on top of an upwardly-revised 0.6% gain in June. At this writing, 10-year and 30-year Treasury yields have responded accordingly, surging back to 2.71% and 3.75%, respectively.
So far, the combination of the tax increases passed last year and reduced growth in government spending through sequestration has produced its desired effect on the U.S. budget deficit. According to the Wall Street Journal, for the fiscal year ending Sept. 30, the Congressional Budget Office (CBO) is now projecting a deficit of $642 billion, down 41% from $1.087 trillion a year earlier and the smallest gap since 2008’s $458.55 billion shortfall.
New Issue Market
In the tax-exempt market, after last week’s busy calendar, the new issue supply is expected to decline this week to just $4.4 billion, not counting a $5.5 billion short-term note deal from the State of California. Notable deals include a $415 million issue from Dallas Fort Worth International Airport and a $335 million State of Connecticut G.O. offering mainly geared toward retail.
The reduced supply should provide some degree of support to the market, although we would expect munis to continue to take their cues from the Treasury market. Another significant backup in Treasury yields would not bode well for tax-exempts.
Increased Focus on Odd-Lot Market
According to industry-wide trade statistics compiled by the MSRB, trading volume in the muni market has been trending down steadily since the financial crash. Between the first quarter of 2008 and the fourth quarter of 2012, the average daily par amount traded for customer purchases, customer sales and interdealer trades all declined by 54%, 67% and 48%, respectively. Increased market volatility during June-July did spur a little uptick in trading activities during 2013 Q2 but, overall, the downtrend has remained fairly constant.
Most notably, the tax-exempt market has also turned into a playground for odd-lot traders: breaking down the daily trading volume by trade size, it is clear that trade sizes below $1 million have remained the most stable while institutional block trade volume ($2 million or more) has collapsed by about 45% over the last five years.
This year, during the June-July selloff, retail buyers (and presumably SMA managers also as their proxies) reportedly stepped up their market involvement even as the mutual funds became net sellers due to shareholder redemptions.
Yet, in spite of their growing importance, retail traders still struggle with price transparency and price discovery issues, particularly on a pre-trade basis. Regulatory constraints on retail markups notwithstanding, trading levels on retail-size blocks still vary wildly, and we’re talking full percentage points here, not just a few basis points.
This trend has certainly not escaped notice by major market participants. Last month, BondDesk, a leading fixed income electronic trading platform, announced it will team up with S&P Capital IQ (the former JJ Kenny pricing service) to offer an odd-lot valuation service. According to their press release, “Odd-Lot Valuations will include bid- and ask-side odd-lot (<$1 million) evaluated prices, a unique market range around these prices and a flexible suite of tools to deliver these outputs to fixed income marketplace participants including retail brokers, market makers, buy-side institutions, interdealer brokers, data providers and alternative trading systems (ATSs). This innovative service will bring a degree of confidence to the execution of odd-lot fixed income trades, provide compliance departments with a consistent way to help assess trade execution quality, and provide investors with valuations that are more indicative of odd lot transactions.” Presumably, this new valuation service will benefit from S&P’s proprietary pricing methodology as well as market data from BondDesk.
Not to be outdone, Lebenthal & Co., LLC, a major regional broker-dealer, just announced it wants to help improve liquidity for municipal odd-lot trading bonds, particularly in the secondary market. To that end, the broker-dealer next month will introduce MuniAxis, an electronic trading platform that employs an open-auction bidding process to match up buyers and sellers of municipal bonds in denominations of less than $1 million. Note that MuniAxis will only act in an agency capacity and will not take on any market risk.
In an interview with the Bond Buyer, Charles Moore, CEO of MuniAxis, touted a new bid-wanted system which would give bidders pre-trade transparency, eBay-style. In other words, just like on eBay, you will be able to see what everyone else is bidding, how many bids there are, and decide if you want to top the high bid. As an “old school” market participant, I would just point out that the traditional bid-wanted system is designed, at least theoretically, to protect the high bidder: traditionally, only the high bidder would be informed of his or her “cover” and of the depth of the bidding, because he or she is the one who goes at risk and commits capital. Would moving to an eBay type auction encourage potential bidders to start low and just wait until the last minute to show their hands? Wouldn’t it put the high bidder at an informational disadvantage as soon as they purchase the bonds? We’re just wondering.
There is no doubt in our mind that all retail/odd-lot trading will ultimately be handled by electronic platforms, for efficiency purposes if nothing else. Between now and then, however, much remains to be done in terms of providing the odd-lot market with the information tools it needs to function efficiently. For instance, how about timely credit information, above and beyond agency ratings?
Disclaimer: The opinions and statements expressed in this column are solely those of the author and Axios Advisors, who are solely responsible for the accuracy and completeness of this column. This column does not reflect the position or views of RICIC, LLC or MuniNetGuide.
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