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Munis drift listlessly as holiday looms; taxable muni index saw high returns

Municipal bonds remained unchanged Tuesday as the market looked positively at the passage of a federal stimulus bill even as a new strain of COVID-19 began to be felt around the world.

Yields on top-rated muni bonds were flat, remaining steady across the AAA scale. Treasury bonds were slightly stronger as equities traded narrowly mixed.

Congress passed the $900 billion stimulus bill late Monday, and it was signed by President Trump. It is the second-largest relief bill in U.S. history. While the bill effectively kills the Municipal Liquidity Facility, it helps the Federal Reserve in its efforts to aid states and local governments without Congressional approval.

In the United Kingdom, the new strain of the coronavirus has led to a lockdown in London with European nations and other countries suspending travel to and from the U.K.

On Tuesday, there was little to no activity in the primary or secondary with the market already having a holiday feel judging by the lackluster mood and tone, according to one New York trader.

“It’s very quiet and there is no supply and no activity,” he said. “There are not a lot of players right now and no deals, and if there’s no new issues a lot of people don’t participate.”

He said many investors only want new issues because they are not confident in the secondary, which was flat and unchanged just two days before Christmas Eve, which sends the market into a two-week holiday snooze.

“A lot of people have hung it up for the year,” the trader said, noting that many investors, issuers and market players are already off this week. “The MMD scales are flat, flat, flat,” he said.

The trader noted the 10-year muni bond was yielding 0.71% on Tuesday. “It should be an opportunity to buy some product while a lot of people are not around, but there’s no supply.”

With little to entice their appetite this week, investors are biding their time until the New Year and the presidential turnover, the trader added.

“I believe [the Biden] administration will be more receptive to helping states and local governments, how much they get and when they will get it passed through Congress is the question,” he continued.

Overall, the sleepy market indicates an uneventful end of the year for municipals. “There is no volatility and you need some volatility to shake the market up,” he said.

And as 2020 nears its close, BofA Securities said most all of its investment-grade muni index yields are ending far below their 2019 year-end levels, with the exception of the high-yield sector, which was up slightly.

“Given the events this year, these yield levels are a strong accomplishment for the market,” BofA Global Research municipal strategists Yingchen Li and Ian Rogow said in a recent report.

The U.S. broad muni index (MUNI) returned 4.869% year-to-date (as of Dec. 16) while the muni master index (U0A0) returned 5.105% and the muni high-yield index (U0HY) returned 4.758%.

Taxable munis posted the highest returns among all fixed-income indexes this year, BofA said. The taxable muni index (TXMB) returned 9.82% year-to-date while the Build America Bonds index (BABS) has seen a 10.55% year-to-date return.

“These two indexes beat the corporate bond index's (C0A0) 9.11% and government index’s 8.01% year-to-date total returns. Back in December 2019, we expected taxable munis to outperform corporates in 2020. This has now become a reality. Still, the yield spread between TXMB and C0A0 was almost constant after the crisis. The compression of this spread should deliver our expected 5% total returns for TXMB in 2021.”

Performance gaps between states caused by the coronavirus pandemic began to disappear as the year progressed.

“The gap between California's and New York's index performance narrowed significantly in the second half," BofA said, noting the California index total returns year-to-date of 6.21%, beating New York's 5.60%.

“However, recall that the gap between total returns for the California and New York indexes was more than 1.50% at the end of May as New York was hit early and hard by the pandemic. So the New York index has caught up quite well since then,” BofA said. “The gap should narrow further in 2021. Historically, the difference between the two indexes' performance is generally around 0.20% or so.”

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BofA noted that higher-rated muni indexes beat lower-rated ones in 2020, but that they expect the opposite to be true in 2021

“We expect total returns for the lower-rated indexes to beat the higher-rated indexes in 2021 due to continued spread compression,” BofA said. “Credit spread recovery started right after the March price avalanche. By now, the process has been well on its way toward a full recovery as the reflation environment remains solid.”

Positive news will help the market as the stimulus package is settled, COVID-19 vaccines are being distributed and the Federal Reserve continues to support the economy and the market.

“We expect all investment-grade index spreads to recover 100% of the crisis widening and high-yield 80% in 2021,” BofA said.

Meanwhile, municipal and corporate bond yields relative to Treasuries continue to decline and have the potential to remain low for an extended period, said Bill Merz, a Minneapolis-based director of fixed-income at U.S. Bank Wealth Management.

“Compression in relative yields drove strong performance in corporate and municipal bonds this year. Low yields reduce the future compensation investors receive for taking on credit risk,” he said.

City and state tax revenues have rebounded while corporations have benefited from attractive borrowing rates and increased cash reserves, he noted.

“Low yields compared to Treasuries have persisted for long periods of time in the past, and we continue to favor the incremental yield found in investment-grade corporate and municipal bonds over Treasuries,” Merz said.

Secondary market
High-grade municipals were flat on Tuesday, according to final readings on Refinitiv MMD’s AAA benchmark scale. Short yields were steady at 0.13% in 2021 and 0.14% in 2022. Out longer, the yield on the 10-year muni was flat at 0.71% while the yield on the 30-year remained at 1.39%. The 10-year muni-to-Treasury ratio was calculated at 77.2% while the 30-year muni-to-Treasury ratio stood at 83.9%, according to MMD.

The ICE AAA municipal yield curve showed short maturities flat at 0.12% in 2021 and 0.14% in 2022. The 10-year maturity was unchanged at 0.70% and the 30-year yield was steady at 1.41%.

The 10-year muni-to-Treasury ratio was calculated at 76% while the 30-year muni-to-Treasury ratio stood at 85%, according to ICE.

The IHS Markit municipal analytics AAA curve showed yields steady at 0.13% in 2021 and 0.14% in 2022. The 10-year was at 0.66% as the 30-year yield was at 1.36%.

Treasuries were stronger as stock prices traded mixed. The three-month Treasury note was yielding 0.09%, the 10-year Treasury was yielding 0.92% and the 30-year Treasury was yielding 1.66%. The Dow fell 0.50%, the S&P 500 dropped 0.15% and the Nasdaq rose 0.40%.

Primary market
There are no negotiated or competitive deals over $50 million that are slated for this week or next.