Municipal bond investors and portfolio managers are likely to hoard nearly $11 billion in cash from redemptions in early October as continued heavy supply and current rates of return keep them on the bench.
"With all the new-issue supply, who's got time to worry about" trying to position for calls and certificate of deposit rollovers, said George Friedlander, managing director of portfolio strategy and fixed-income high net worth at Smith Barney, Harris Upham & Co.
About $8 billion of the redemptions is likely to come in cash coupon payments on Oct. 1, according to Aaron S. Gurwitz, vice president of fixed-income research at Goldman, Sachs & Co.
Prerefunded bonds being redeemed in October should generate $2.5 billion, Mr. Gurwitz said. He declined to speculate how much investors might receive from maturing certificates of deposit, or how much of that cash could be channeled into the municipal market.
David Madigan, director of municipal analytics at Merrill Lynch & Co., said investors are saying that "I don't have to buy this week because there's more coming."
Uncertainty about the economy and the impact of the November election on interest rates and inflation is also keeping investors in the stands, Mr. Madigan added.
"Interest rates could move 50 basis points between now and year-ended, but people just aren't sure which way they'll go. So there's nervousness," Mr. Madigan said.
Although the volume of redemptions for October is the largest since it hit about $42 billion in July, investors may not jump on the cash to invest in municipals, Mr. Gurwitz agreed.
"I'm getting a lot of questions" from both issuers and investors about October cash, he said. "I'm telling them there are a lot more important things going on in the muni market than this."
Supply Overtakes Demand
Projections of supply in the municipal market have reached record levels in recent weeks as historically low bond yields have prompted issuers to schedule a wave of refundings. On Sept. 14, The Bond Buyer's 30-day visible supply calendar rose to $8.15 billion, its highest level since November 1985. Last Tuesday, visible supply hit an all-time high of $10.86 billion.
While cash from a wave of bond calls, maturing short-term notes, and coupon payments sent investors rushing to buy a limited supply of tax-exempts in July, the relationship between supply and demand is changing, said Richard Ciccarone, head of fixed-income research for Kemper Securities Group Inc.
On June 18, 30-day visible supply totaled only $2.78 billion, Mr. Ciccarone said. "We didn't have anything near the amount [of supply] right now," he said.
"There weren't enough bonds really to come into the market then," he added. "Now, demand will not satisfy the visible supply."
Last October, municipal bonds benefited from a good amount of crossover buying. At that time, investors in taxable bonds facing dismally low yields for reinvestment of maturing certificates of deposit poured cash into short-term tax-exempts.
But this year, investors are aware of low reinvestment yields and have had more time to research alternatives to investing in municipals. "I don't think you're going to have this [certificates of deposit] rate shock that occurred last year," said Joseph A. Piraro, assistant vice president and portfolio manager at Van Kampen Merritt.
As a result, prices in the primary market are expected to be lower than those available on outstanding issues, as underwriters seek to price deals at levels that will entice buyers.
Meanwhile, investors facing a huge supply onslaught usually become highly selective, often postponing purchases in anticipation of further price declines, several dealers said.
While the 30-day visible supply is posting record levels, it is highly uncertain whether all the bonds will come to market. This is because market gyrations, including some strong gains among sectors of the Treasury market, have eliminated some savings an issuer would see by refunding high-coupon bonds, Mr. Gurwitz and others said.
If rates stay at current levels, little additional debt will be sold, Mr. Gurwitz added. This could lead to a lack of, or relatively modest, supply, he said.
In August and early September, municipal yields dropped to levels that would have caused a deluge of refundings and overwhelmed investor demand. But now, Mr. Gurwitz said, "I think yields have risen more than they need to the regulate supply," causing issuers to postpone a number of deals.
The market needs to find a level at which intermediate-term municipal bond yields versus those on Treasury bonds with similar maturities make some refundings attractive, but do not flood the market, the Goldman strategist said.
"Finding that level is going to be the major influence," as opposed to the amount of cash coming into the market, Mr. Gurwitz added.
Municipals Still Attractive
Despite factors keeping investors on the sidelines, municipals remain attractive compared to Treasuries and other taxable securities.
"With the alternatives out there, municipals are attractive if you expect a tax increase" after the November election, Mr. Ciccarone said.
He said short-term municipal yields are already equal to or slightly above taxables, even before the taxable equivalent yield is calculated.
Mr. Ciccarone pointed out that six-month certificates of deposit last week yielded about 2.6%, compared with a 2.9% yield available on top-rated, short-term municipals maturing in six months.
Meanwhile, the Bank of New York is offering taxable investors yields in the range of 2.85% on one-year certificates of deposit before state, local, and federal taxes are deducted, James J. Cooner, senior vice president and manager of the bank's tax-exempt bond division, said. Top-rated one-year municipals are yielding about 3%.
"Tax-exempt yields are a lot lower than they were last year," but are "probably more attractive," especially compared with Treasuries on an after-tax basis, said Triet Nguyen, senior vice president and portfolio manager of the Putnam Cos.
The Bond Buyer's one-year note index yielded 3.12% on Sept. 23. It yielded 4.69% on Sept. 25, 1991.
It "would take some education on the part of the industry" to entice buyers and abate investors' concerns over the low yields and heavy supply, Mr. Nguyen said.