- Bonds have dropped 2.7% this month, worst January on record
- “It feels like everything is on sale,” says Thornburg’s Lando
Municipal-bond investors are starting to look for bargain buys after the market saw its worst selloff since the first half of 2020.
As money managers get increasingly concerned about the Federal Reserve hiking rates as soon as March, yields have jumped, risk premiums have risen, and securities that looked expensive a few months ago look less so now. The benchmark for top-rated 10-year bonds yields more than 1.55%, a jump of around 0.5 percentage point from the start of the year, with levels weakening further on Monday.
“It feels like everything is on sale,” said Eve Lando, a portfolio manager at Thornburg Investment Management Inc.
The flip side of that is losses for investors on existing holdings: Municipals have posted a 2.7% decline this month, the worst performance for the month of January on record, according to Bloomberg indexes. Still, the selloff is being driven by factors that are external to the muni market, which should provide investors some comfort, Lando said.
“Right now, all of this commotion is happening outside of our market, there wasn’t a bankruptcy or some unforeseen event in munis – this is outside forces,” she said. “Credit quality has been spectacular in the last year.”
Lando is adding exposure to existing names and actively playing in the primary market when new deals price. She said that her group looks closely at how a lingering pandemic might affect bonds, typically steering clear of debt sold by entities like convention centers that continue to be hurt by the virus. She also likes borrowers that can pass along higher inflationary costs instead of eroding underlying credit quality, like toll roads that can raise rates.
Boosting Yields
For months, municipal bonds were a seller’s market for issuers, and deals were routinely oversubscribed, allowing bankers to slash yields on offerings. Now, underwriters are often increasing the yields on offerings to lure buyers.
Thomas Jefferson University sold bonds last week due in 2056 yielding 3.01%. Kimberly Olsan, senior vice president of municipal bond trading at FHN Financial said in a Jan. 31 note that similar sales last year priced at yields that were 0.50 to 0.75 percentage point lower, adding that lower-rated deals are “being priced to attract buying interest.”
“The market is still trying to adjust to a yield range where more active buying can be developed,” she said.
Still, Barclays Plc strategists warned last week that investors shouldn’t rush back into the market to buy. “Patience is a virtue,” they titled a Jan. 28 note.
Longer-dated bonds may struggle with continued market volatility and investor redemptions, they said. Meanwhile, they said they are starting to see some more value in shorter-dated bonds for more defensive investors.
“Investors should be able to find some attractive opportunities in the near future but not be rushing to buy, although even at current levels some might start slowly adding exposure,” strategists led by Mikhail Foux said.
Averaging In
Phasing into the bonds may make sense because it’s hard to know precisely where the bottom is, according to municipal bond strategists at Citigroup.
“We are worried that the markets will stabilize and municipal yields will ratchet back down quickly, thereby denying us the opportunity to buy cheaper paper and realize better absolute returns for the calendar year,” the group led by Vikram Rai wrote in a note published Monday.
“We recommend buying some paper at current levels. Essentially, we are advocating the FOMO (Fear of Missing Out) trade! But, we also recommend keeping some cash handy, potentially for use later,” they said specifically recommending investors buy long-paper given that ratios have cheapened materially.
Duane McAllister, co-head of municipal investments at Baird, said that investors are looking to sell securities that will be the least painful for them to get rid of, such as bonds with shorter call dates, given those bonds will see fewer price declines than some longer-dated securities.
“We actually have been trying to take advantage of that,” he said.
Baird has been buying the 5 to 15 year part of the curve, which has gotten hit hardest, because it was the most expensive to begin with, said Lyle Fitterer, co-head of municipal investments at Baird, which oversees around $10.6 billion of the debt. Yields on some bonds are as much as 90 basis points higher than six to eight weeks ago.
“We are seeing some messages just now saying that buyers are stepping up,” Fitterer said on Friday. “The bids that are out this afternoon are getting a little better levels than what we saw this morning.”
“I think people are going to come around to the fact that valuations look a lot more attractive.”
Bloomberg Markets
By Danielle Moran and Amanda Albright
January 31, 2022, 9:38 AM PST
— With assistance by Martin Z Braun