Following yesterday's increase in short-term interest rates, some analysts are predicting that the taxable and tax-exempt yield curves will continue moving in different directions as they have for most of this year. If that happens, the tax-exempt bond market will probably move in one direction while the tax-exempt swap market moves in another.
And that means municipalities looking for swaps may find better rates if they opt for transactions based on taxable indexes, instead of the more conventional Public Securities Association or J.J. Kenny indexes.
On one side, the taxable yield curve is expected to flatten, as short rates rise and long rates remain steady or drop slightly. Since January, the spread between the three-month Treasury bill and the 30-year bond has shrunk from 329 basis points to 269 points.
But on the other side, the tax-exempt yield curve is expected to steepen, as short rates remain steady and long-term rates rise slightly. Since January, the spread between the PSA's municipal swap index and The Bond Buyer's 20 bond index of long-term general obligation debt has grown from 216 basis points to 351 points.
These differing effects have caused municipal swap rates to rise faster than municipal bond rates. That's because tax-exempt swap rates are still, in large measure, keyed off of the taxable yield curve.
According to a research report by Christopher Dillon, municipal market strategist at J.P. Morgan Securities Inc., the spread between a five-year swap and a five-year bond has moved almost 60 basis points in the last year.
A year ago, the fixed-rate side of a five-year swap based on the J.J. Kenny high-grade index was about 30 basis points lower than the yield on a triple-A, five-year municipal bond.
By last week, the situation had reversed and the swap rate was 30 points higher than the bond rate.
The change is also evident in figures supplied to The Bond Buyer by EuroBroker's Capital Markets and Municipal Market Data.
The figures further show that the short-term swap market has underperformed the short end of the municipal market more than the long-term swap market has underperformed the long end of the municipal market.
On January 28, the first date swap figures were submitted, EuroBrokers found that the average fixed rate that a dealer would pay on a two-year swap tied to the PSA index was 2.91%, and on a 10-year swap, 4.12%,
On Monday, EuroBrokers said the average rate on a two-year swap was 4.42%, up 151 basis points, and the average rate on a 10-year swap was 5.28%, up 116 basis points.
Back in January, MMD said the rate on a triple-A, two-year bond was 3.15% and the rate on a 10-year bond was 4.40%.
On Monday, the rate on a two-year bond was 4.30%, up 115 points, and the rate on a 10-year bond was 5.40%, up 100 points,
So back in January, the two-year swap rate was 24 points below the bond rate. On Monday, the swap rate was 12 points higher than the bond rate.
Back in January, the 10-year swap rate was 28 points below the bond rate. On Monday, it was 12 points lower.
On recent short-term municipal swap transactions, therefore, dealers have turned to swaps based on taxable market indexes, such as the London Interbank Offered Rate, in order to offer municipal issuers savings with swaps.