Sometimes, the market only hears what it wants to hear. Janet Yellen learned that lesson the hard way last week in her first post-FOMC press conference. Her remarks, as cautiously worded as they could possibly be, were still interpreted by traders to mean that an actual rate tightening could occur as soon as the second quarter of next year. This, in turn, led to a massive flattening of the Treasury curve: on Monday, the 5-to-30 year slope hit 183 Bps, its narrowest point since October 2009. So far, most of the flattening has occurred inside of 10 years, leaving the benchmark 10-year and 30-year Treasury yields relatively stable at around 2.75% and 3.60%, respectively.
The municipal yield curve also flattened dramatically in sympathy with the Treasury curve. According to The Bond Buyer, yields on bonds maturing inside of five years spiked by more than 30 Bps since the FOMC meeting last Wednesday. By Monday night, the 5-30 year slope had compressed by a stunning 25 Bps. The quasi-instantaneous response to the Treasury move was rather surprising for the normally slow-moving tax-exempt market, leading us to wonder if a new age of muni volatility is upon us.
In fact, after the strong February rally, the front end of the muni curve was already in overvalued territory and thus vulnerable to a correction. No wonder the biggest adjustments were in the short maturity ratios: since 3/11, just over the span of 2 weeks, the 2 year ratio has gone from 73.1% to 95.0% and the 5 year from 70% to 79.8%. Yet, the 10 year and 30 year ratios have barely budged at 93.8% and 103.3%, respectively.
The municipal yield curve also flattened dramatically in sympathy with the Treasury curve.
Thankfully, once Treasuries started to stabilize on Wednesday, and with ratios back in a more technically defensible range, municipals have caught a bid and rebounded between 3-5 Bps. This may turn out to be just a temporary reprieve though, should next week’s March employment come in stronger than expected.
New Issue Market
This week’s new issue calendar should fall short of $5 billion once again. Notable deals include a $793 million State of California Lease Revenue Bonds to finance new jail facilities and a $706 million refunding for Atlanta’s Hartsfield Airport. The New York City Municipal Water Finance Authority will also offer $480 million of Water & Sewer Revenue Bonds. Of the three, the Atlanta Airport issue holds the greatest promise of offering decent yields for income-starved investors.
Puerto Rico’s Retail Trading Mess
When it comes to Puerto Rico, there is never any dearth of controversy, it seems. The PR G.O. issue was widely touted as a ringing success when it came to market a couple of weeks ago. By now, it has become quite apparent that many of the participants were short-term traders looking for a quick profit or retail traders looking to push bonds onto retail at a hefty markup. While the bonds did trade up initially to about 98, prices have since sunken to as low as 91 before recovering slightly. Needless to say, the recent announcement of another $2 billion in COFINA and COFIM financing scheduled for later this year probably didn’t help the bonds’ performance in the secondary market either.
For now, the PR G.O. 8.00% of 2035 appears to have found a near-term equilibrium at or just over the original issue price. Could this be a coincidence? We think not. With quarter-end approaching, we wouldn’t be surprised to see some of the larger participants in the deal attempt to prevent, or at least postpone, any short-term price decline until next week. After all, if you’re already long $100 million bonds, wouldn’t you pay up a few points for another $3 million, just to support a stronger mark at March 31 and safeguard this quarter’s performance bonus? But then, that’s just pure speculation on our part and we’re probably just being too cynical once again.
Even before the Commonwealth’s mega-deal was priced, we were concerned that the minimum trade denomination had been lowered from an initially proposed $50 million to a mere $100,000. Even though the lower limit was meant to prevent “retail” participation in this highly risky transaction, we suspected it wouldn’t keep many individual investors away from the issue. Furthermore, should PR ever get into a workout situation, the logistics of communicating with a multiplicity of smaller investors could prove something of a nightmare.
As it turned out, even the lower trade size limit, specifically listed in the Offering Statement, was ignored in some quarters. Trades in amounts less than $100,000 started showing up in EMMA’s daily trade reports, prompting outcries from market observers, including The Bond Buyer, which found nearly 70 trades in violation of the minimum denomination requirement. When notified of these transgressions, FINRA has reportedly started an investigation into the matter. The plot thickened, as they say, when some of the offending trades were subsequently erased from public trade reports, prompting speculation about a “cover-up” by the regulatory agencies. While the cloak-and dagger stuff is fun to read, we do believe it was just an honest attempt by the MSRB to remove trades that probably were done in error and have been reversed.
As an aside, we should point out that violations of minimum denominations are not all that uncommon, particularly when it comes to unrated or high yield issues (Bond salesmen are notoriously loath to read official statements). However, this latest episode involves one of the most heavily scrutinized bond issues in muni history and the minimum trade limit was discussed ad nauseam in the media, so there’s really no excuse for such blatant flaunting of the rules. Besides, compliance with minimum denomination rules should be fairly easily enforced through current technology (trading system vendors, are you listening?).
All in all, this was hardly a shining moment in the history of municipal trading. And another controversy that Puerto Rico can do without.
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