Municipal bond prices declined in October continuing September’s price slide. Bond yields in the 10 year range increased slightly, approximately 4-5 basis points during the month. Recent elevated bond issuance levels coupled with waning demand should push bond yields to more attractive levels in the near term.
The elevated new issue volume has been a lead story in our marketplace throughout 2010 and October did not deviate from past scripts in this regard. Through October, new issue volume is ahead of 2009 levels with more than $42 billion issued last month alone.
The theme of decreasing non-taxable volume continues as issuers are opting to access the taxable market taking advantage of the 35% federal subsidy of their interest cost offered by the Build America Bond (BAB) program. The result of the BAB program has been to siphon municipal bond supply from the non-taxable to the taxable sector. Approximately 30% of new issue volume in 2010 has been in the BAB sector. With the program set to expire at year end and no agreement yet in Congress to extend the program, there will be a mad rush of issuance in the coming weeks.
The heightened possibility of non-extension of the BAB program may result in higher yields in long maturity, non-taxable bonds; investors may begin to demand higher yields for long dated issues in expectation that increased future non-taxable supply (resulting from sunset of BAB program) will push bond prices lower. This, of course, is conjecture on our part at this point, but is something we are watching closely.
Lastly, we continue to stress the importance of building liquidity into portfolios (please see the discussion of portfolio liquidity in our “Municipal Market Update“, July 2010). A trend of reduced secondary market trading activity in the marketplace continues to prevail for a number of structural reasons. Additionally, we expect to see increased municipal bond credit disclosure requirements in the months ahead. This positive development will greatly improve market information to the broker dealer and investor communities and, in certain instances, further limit liquidity of certain issuers. This should create problems for some investors and opportunities for others.
For more information contact your Bernardi Securities, Inc. Investment Specialist.