Market Outlook

When China sneezes, as they say, the rest of the world catches cold. This was certainly true this week, when a reported deceleration in Chinese economic growth triggered a worldwide selloff in emerging market currencies. The trigger event was apparently a drop in the HSBC preliminary manufacturing Purchasing Managers’ Index for China to its lowest level in six months.

It certainly makes sense for investors to be concerned about those emerging economies that have benefited the most from the central banks’ liquidity party, now that the punch bowl is being taken away. Bear in mind that, for all the “taper” talk, liquidity remains plentiful as the monthly $10 billion reduction in bond purchases is but a drop in the bucket compared to the $75 billion or so the Fed is still committed to buying.

Given all the turmoil overseas, is it any wonder investors are rediscovering municipals for their attractive risk-adjusted return characteristics?

The domestic economy too, appears to have decelerated coming into the new year. Yesterday’s Leading Economic Indicators (LEI) came out at an anemic 0.1% for the month of December, although November’s number did get revised up to 1.00% from 0.8%.

The global selloff played right into bond traders’ hands and they gleefully pushed the 10-year Treasury yield down past the 2.80% mark, to 2.73% at this writing.

All this leaves the fixed-income markets in an interesting (read: more vulnerable) position going into next week’s FOMC meeting and the release of the January payrolls number the week after. We would expect some back-and-fill action to occur by the end of next week as market participants once again set up for their monthly employment report routine.

Given all the turmoil overseas, is it any wonder investors are rediscovering municipals for their attractive risk-adjusted return characteristics? After today’s move, the yield on AAA-rated tax-exempt paper in the 30-year range should re-test its low going back to last July.

Do two weeks make a trend? Muni market participants certainly hope so. Weekly-reporting muni funds posted inflows again for the week ended January 22, albeit only a modest $86 million, according to Lipper. Long-term muni bond funds recorded their second straight week of inflows, at $25 million, versus inflows of $102 million last week. High-yield muni bond funds recorded their third week of inflows, at $160 million. The previous week, they reported inflows of $276 million.

Puerto Rico Update

The muni market’s improved technicals have helped Puerto Rico paper weather the latest fear-mongering efforts by the nation’s media. According to a recent New York Times article, Morgan Stanley has been trying to round up interest from a diverse group of potential investors, including hedge funds, toward a potential $2 billion financing package for PR, reportedly at interest rates as high as 10%. This latest “scoop” was promptly refuted by Commonwealth officials as just an unsolicited effort on Morgan Stanley’s part, one which they have already rejected.

Truth be told, the rating agencies’ fixation on PR’s “market access,” while justified, is now bordering on the absurd. Moody’s, in particular, has been warning the Commonwealth to demonstrate market access by the end of January or face a potential downgrade. Obviously, with only a week to go before month-end, the Padilla team is not going to make that deadline. Will Moody’s use that excuse to justify a downgrade? We hope not.

The latest rumor, unconfirmed we may add, is that PR officials are meeting with the rating agencies about a $500 million COFINA deal scheduled to come to market in February.

It’s not clear which COFINA entity will be doing the financing, although we would bet on the recently created local version of COFINA. Late yesterday, PR’s Senate approved the creation of this new public corporation, designed to offload about $600 million of local municipal debt from the Commonwealth’s balance sheet.

It would be interesting to see which financing vehicle, a third-lien regular COFINA issue or a first-lien local COFINA deal will fetch the best terms for the Commonwealth. We, for one, would prefer the time-tested security of the regular COFINA structure over a gimmicky and untested new entity.

Detroit Update

As you may have heard by now, after a group of private non-profit foundations has agreed to provide $330 million toward preserving Detroit’s art collection and paying off some of the City’s pension liabilities, the State of Michigan has also stepped up to the plate. On Wednesday, Governor Rick Snyder and top State lawmakers announced plans to contribute another $350 million, spread over the next 20 years, toward the city’s unfunded pension liabilities. The State’s pledge will presumably be funded through securitization of its annual tobacco settlement payments.

Governor Snyder pointed out that the State’s pledge lies outside of the bankruptcy proceedings and will be earmarked solely for hard-working Detroit pensioners. As such, it should not be viewed as a state bailout of the Wall Street bondholders.

Aside from its disturbing “Wall Street versus Main Street” overtone, Governor Snyder’s preferential treatment for one class of unsecured creditors versus another will likely run into legal challenges by the bondholders and bond insurers.

Without purporting to be legal experts, our first impression is that this may ultimately prove to be a positive for bondholders, particularly for G.O. bondholders. Since the latter are deemed unsecured creditors on a par with pensioners, reduced claims by the city’s retirement systems should potentially leave more money in the “bankruptcy pot” to be divvied up among bondholders. To the extent the unions and their pension funds can be removed from the negotiating table, the City should have an easier time, politically speaking, to accommodate the claims of the remaining unsecured creditors. Thus, at least on the surface, potential recovery prospects for G.O. bondholders should improve.

We hasten to add that the bond insurers and bondholders have definitely not given up on challenging the city’s treatment of its GO debt as unsecured claims. That issue, one that is of great significance to our market, still has to be decided the bankruptcy court.

[Note: MuniBond Insights will not be published on January 28th due to travel commitments. We’ll see you back here on the 31st.]

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.