With net redemptions from municipal bond funds topping $1 billion in the past three weeks, the usual October and November pickup in new issues - if it occurs - could spell trouble.
James Kochan, head of fixed-in-come asset management at Robert W. Baird & Co., said that the $1 billion of redemption as reported by AMG Data Services may not be "dreadful," but it is "another negative piece of information in a market that has plenty to chew on already." If the municipal market sees any kind of a recovery in new-issue volume in the fourth quarter, "it seems to me that the muni market is going to be in trouble," Kochan said.
"We're rich to Treasuries by almost any measure, and Treasuries ain't doing so hot themselves," he said.
That the tax-exempt market didn't take the redemptions harder than they did further illustrates the degree to which scant new-issue supply has sheltered the market from sharper losses, Kochan said.
According to Robert Adler, president of AMG Data Services, while municipal bond funds have seen more than $1 billion of net redemptions over the past three weeks, that figure could climb when the numbers come in from two big fund groups that report monthly.
The week ended Sept. 28 saw more than $479 million of net redemptions from municipal bond funds, Adler said. Net redemptions for the weeks ended Sept. 14, Sept. 21, and Sept. 28 totaled $1.024 billion. Adler noted that nearly half of that came out of no-load funds.
Two big fund groups, the Franklin Group of Funds, which has about $40.1 billion of municipal assets, and Merrill Lynch & Co.'s funds, which has about $9.4 billion, report monthly, Adler said.
If Franklin, which alone accounts for more than 16% of the open end municipal fund assets that AMG tracks, and other monthly reporters such as Merrill Lynch and Lord Abbett follow the trend of the weekly reporters, "then this [redemptions] number could well be much higher," Adler said.
As of Sept. 28, AMG tracked municipal bond fund assets totaling $245.5 billion and representing 1,549 funds, Adler said. Funds reporting weekly represent $183 billion, or roughly 75% of that total.
Kochan said new financings usually pick up in October and November, and sometimes even into December because they're sandwiched between "the summer lull" and yearend.
"We haven't had much volume at all [this year] because so much borrowing took place last year," Kochan said, adding that issuers probably don't have much need for money now. In addition, issuers' cash flow is up because of increased tax receipts, he said.
"But still, if you get even a moderate increase in volume here towards yearend, I think it's going to be hard to digest, particularly [since] bond prices aren't going up so one would expect that the outflow from the mutual funds will continue," Kochan said. "And it's not just in munis. It's the whole fixed-income area is experiencing an outflow."
While another Federal Reserve tightening won't cure all of muncipals' woes, "I think to ... reduce the extra-ordinary amount of pessimism in this market, a round of Fed tightening would probably help," Kochan said.
"The more we see stronger economic data and the longer the Fed delays in tightening, the more likely it becomes that bond yields go substantially higher before this cycle is over," he said. Investors fear that scenario, and it's what is keeping them sidelined.
"They are terribly afraid that before this cycle's over it's not just going to be 8% on long Treasuries, but it's going to be 8.5%," Kochan said.
In rating activity Friday, Moody's Investors Service downgraded Los Angeles County general obligation bonds to A1 from Aa, and also lowered the county's 1986 pension certificates to A from A1, a Moody's analyst said.
The new pension obligation bonds being offered in the next few weeks were rated A, and the ratings on the outstanding leases were confirmed at A and Baal, depending on what the asset securing the lease is, the analyst said.
In the secondary market on Friday, activity was light, with yields on high-grade bonds ending unchanged, and dollar bond prices finishing unchanged to 1/8 point lower.
This week in new issues, a Dillon, Read & Co. group is expected to bring $240 million New York State Thruway Authority highway and bridge trust fund bonds on Wednesday. A source familiar with the deal said it is possible that at least a portion of the offering may be insured.
The negotiated slate also features $98 million of California Statewide Communities Development Authority certificates of participation through Morgan, Stanley & Co. The deal is expected tomorrow.
Topping the competitive calendar are $160 million of Maryland general obligation bonds on Wednesday. Also that day, the Port Authority of New York and New Jersey is expected to sell $100 million of revenue bonds.
In other news Friday, the 30-day visible supply of municipal bonds totaled $2.7 billion, up $565.1 million from Thursday. That comprised $1.43 billion of competitive bonds, up $330 million from Thursday, and $1.28 billion of negotiated bonds, up $235 million.
Also Friday, Standard & Poor's Blue List of municipal bonds rose $57.8 million to $2.03 billion.
