Happy times are back in the bond market, at least until the next payrolls report on October 4th. In the absence of significant economic data, fixed-income traders have been able to maintain the positive momentum from last week’s “No Fed Taper” rally. The potential threat of a government shutdown in barely a week’s time is also keeping the flight-to-quality bid in the market.
With no current headwind, the yields on the benchmark 10-year and 30-year Treasuries have dropped to about 2.65% and 3.67%, respectively.
… new yield levels have yet to be tested by any real supply, so some degree of caution might be warranted at this point.
Not to be outdone, the muni market continues to display a constructive tone so far this week, an impressive feat given last week’s explosive move. According to Barclays, the 10-year muni-to-Treasury ratio has declined to 95%, a level not seen since the beginning of the bond market rout in late May. The 30-year ratio also dropped by three percentage points to 111%, the lowest since mid-July.
Of course, the new yield levels have yet to be tested by any real supply, so some degree of caution might be warranted at this point.
New Issue Market
Education seems to be the theme for this week’s new issue calendar, itself quite light for a non-holiday week. The University of California will lead the negotiated slate with a $1.9 billion offering, consisting of a mix of tax-exempt and taxable paper. Given the more positive outlook for the Golden State in general, and recent increases in State funding for the U Cal system, we expect this Aa1/AA/AA+ deal will have no difficulty finding a home.
Other smaller university deals will include Western Michigan University and the University of Oklahoma.
G.O. issues are expected to dominate the competitive calendar, including a $500 million offering from New York City and $122 million from Denver, Colorado.
From Depression to Elation
In the absence of supply, traders are refocusing their attention on depressed sectors of the market. One of the major beneficiaries has been the Puerto Rico (PR) market, where buyers can still find decent size blocks at historically wide spreads, assuming they can get comfortable with the island’s credit outlook. It’s fair to say that, after weeks of negative headlines from the national media, the fear factor is gradually coming out of the PR market. Hopefully, this will pave the way for more rational credit risk pricing going forward.
As a case in point, the PR G.O.s 6 ½ of 7/1/2040, which famously traded into a 10.08% bid (67 dollar price) on September 9th, are now marked at around 8.20%, or a dollar price of about 81. For whoever was lucky enough to purchase those bonds, this represents a 21% gain in just two weeks.
With Obamacare now part of the debt ceiling debate, the outlook for the health care sector has become even more complex.
In contrast to the tax-exempt PR paper, taxable PR issues have not moved very much, perhaps because they’re largely held in institutional accounts with longer holding horizon, such as insurance companies. Investors who can’t take advantage of the triple tax exemption and are sensitive to dollar price may want to take another look at PR taxables.
Another major beneficiary of the market rebound is the high yield sector, which we’ve been talking up for several weeks. Large, liquid names such as the Iowa Fertilizer 5 ¼ in 2025 have snapped back 94 basis points in yield and tightened by 55 basis points in spread.
With Obamacare now part of the debt ceiling debate, the outlook for the health care sector has become even more complex. Regardless of one’s view regarding the potential impact of health care reform on individual health systems, one thing is clear: the current spread between AA-rated and low A/BBB names has become too compressed. For instance, only 30 basis points separate the Aa3-rated Sutter Health System, CA from the Baa1/BBB+ rated Christ Hospital in Hamilton, Ohio. Based on such tight spread relationships, investors should look to swap out of lower-quality paper and upgrade within their health care exposure, if nothing else.
Overall, the tax-exempt market appears to have moved out of its “oversold” condition. What remains to be seen is whether the recent rally will hold up in the face of more normal supply conditions. Market participants are also awaiting this week’s mutual fund flow numbers with baited breath. The high yield complex already saw positive flows last week. Should the investment grade funds follow suit this week, the technical outlook for the entire market will improve dramatically.
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