It’s Friday the 13th and not too many bond investors are feeling lucky this morning.
Except for an always unpredictable weekly jobless claims number, most of the recent economic data has come in stronger than expected. November retail sales rose 0.7%, following a 0.6% increase in October, providing further evidence of the US consumer’s resiliency.
The new mood of bi-partisan cooperation in Washington, at least while it lasts, should allay fears of more fiscal restraint and pave the way for the Fed to start tapering, if not next week, then certainly in the first quarter.
On top of it all, the government market also had significant new supply to absorb this week. Most of the auctions ended with mediocre results: the 30-year sale had to fetch the highest yield level in more than two years in order to attract buyers.
After rallying earlier in the week, Treasury yields have gravitated back to where they closed last Friday after the release of the November employment number, i.e. about 2.86% on the 10-year and 3.88% on the 30-year paper.
Luck hasn’t been on the side of the muni bond funds either. Shareholder withdrawals have continued for what is now the 29th consecutive week, and, to everyone’s dismay, they’re re-accelerating. According to Lipper, weekly reporting funds saw outflows of $1.90 billion for the week ended December 11, twice as much as the $875 million recorded the previous week. Long-term funds accounted for more than half of outflows, at $1.05 billion, compared to $688 million the previous week. High-yield muni fund outflows more than doubled this week, to $425 million.
While Treasury yields are virtually unchanged on the week, tax-exempt yields have nudged up to accommodate a record $11 billion in new issues this week. The Bond Buyer’s 20-Bond GO Index increased 4 basis points this week, to 4.74%, its highest level since Sept. 12, 2013. The Revenue Bond Index, rose seven basis points to 5.37%, the highest it has been since May 26, 2011.
At least one municipal participant should feel a bit more fortunate about its outlook going into the new year: the State of Illinois. The Prairie State’s first G.O. bond issue after its legislature passed a landmark pension reform did benefit from much tighter spreads. The $350 million taxable deal was sold competitively to Bank of America at a reported +188 vs Treasuries and re-offered at +175. This represents a significant tightening from the State’s last taxable offering back in April, which, according to Bloomberg, required a spread of +260. On the tax-exempt side, Municipal Market Data (MMD) estimates the current spread on a 10 year Illinois G.O. at about +158 off AAA, down from +178 in mid-October. Although election year posturing may obfuscate the fiscal outlook over the next few months, a target tax-exempt spread of +125 would not be unrealistic by the time the next Governor is elected (or re-elected, as the case may be).
Down in the Caribbean, we find quite a different story. It appears Puerto Rico will be ending the year with the double threat of downgrade from Fitch and Moody’s hanging over it.
Moody’s latest salvo came after market hours on Wednesday night. The rating agency “placed on review for downgrade the general obligation (G.O.) rating of the Commonwealth of Puerto Rico. At the same time, ratings that are capped by or linked to the Commonwealth’s G.O. rating were also placed on review, including the Puerto Rico Sales Tax Financing Corporation’s (COFINA’s) senior and junior lien bonds”. During the review period, Moody’s reportedly will focus on the Commonwealth’s “ability and willingness to access the long-term capital markets”, among other factors.
All three rating agencies have now mentioned “continued market access” as a major driver in their ultimate rating decision. There is irony to be found in the bond raters’ newfound fixation on “market access:” surely, if you’re worried about market access, a potential downgrade to junk wouldn’t help the cause, would it?
It is true that the muni market has never been faced with systemic risk on the scale that Puerto Rico represents. Many of us old timers in the market would like to take comfort in the fact that previous fiscal disasters such as California have ultimately been worked out. However, for a US “sovereign” or “quasi-sovereign” entity to have its market access questioned is quite unprecedented. For all its foibles, the Golden State never faced even the possibility of losing its access to the capital markets.
Recently, the Commonwealth was able to repay its $400 million short-term loan from Barclays with cash from the GDB. This shows it still has access to decent liquidity, at least for the time being. However, without better transparency about the GDB’s true liquidity position, no one really knows what the real story is, another example of the kind of selective disclosure practice that continues to hurt PR’s image in the marketplace.
The continuing contraction of the PR economy has also unnerved the rating agencies. On a market outlook call yesterday, S&P admitted there could be a scenario where the PR economy contracts enough to render any improvement on the fiscal side moot.
After a stronger-than-expected October, revenue collections came in below expectations in November. General fund revenues were 4.25% less than the November 2012 figure and, more importantly, 9.1% below government projections for the month.
The sales and use tax (SUT) revenues supporting the COFINA bonds are also substantially behind projections. November SUT collections totaled $98 million, 26.3% below projections but still up 3.2% above November 2012. For the first five months of the fiscal year they were up 5.8% over the first five months of fiscal 2012.
Not surprisingly, Moody’s announcement has triggered another round of selloff in PR names this week. Our sources on the street reported the bid side weakening by as much as 150 basis points on some issues, compared to just a few days ago. As of last night, according to MMD, the spread on 10 year PR paper has ballooned to +710 off AAA, compared to just +270 at this time last year. As a result, the absolute yield is once again nearing double-digit territory, at about 9.82%.
At this point, we continue to view Puerto Rico as a trading opportunity, not as an investment, and only for aggressive investors who can stomach a fair amount of market volatility. Either way, we believe everything should come to a head some time during the first half of 2014.
So, as we enter the home stretch for 2013, the fiscal fortunes of the muni market’s worst “sovereign” or “quasi-sovereign” issues, Illinois and Puerto Rico, are starting to diverge sharply. Perhaps Puerto Rico officials should take a shot at today’s Mega Millions lottery? They really could use a windfall of $400 million right now.
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