The tax-exempt market has skidded into a new month, with yields rising slightly over the last two weeks. Particularly affected have been shorter maturity bonds, where individual investors have rebuffed too-low absolute yields, and lower rated/risky sector bonds that have been hampered by worsening credit fears and a setback in institutional risk taking. Still, there has been little sign of forced selling by large investors, and the Federal government's efforts to support both Citibank and AIG are positives for our sector. Further, President Obama's new budget proposal should underwrite more demand for tax-exempt bonds by both raising marginal tax rates and cutting the value of competing tax shelters like the mortgage interest deduction. This puts the muni sector in a slightly better place to receive new sponsorship, especially because recent price concessions by sellers have made bonds through the 10yr more attractive. Still, this week, any positives may break against the largest new issue calendar so far this year, and a potential reinvigoration of flight-to-safety buying of Treasuries could further dilute institutional demand for munis.
A new month brings uncertainty, but not all the news is bad.
Investors seeking total return should look to shorter maturity bonds; following recent price declines, the 5yr is offering large concessions to current buyers. We also exhort more income-oriented buying of insured, safe-sector loans that have lost investment grade ratings. Pre-refunded bonds have better liquidity and near-term price performance. We also advise generic caution with respect to health care issuers, but higher yields in this sector are creating attractive opportunities for selected credits.
Ambac's sharp quarterly loss highlights the challenges for legacy insurers; MBIA's results are this week. Renewed pleas for a bailout of MBIA are attracting interest in insured bonds. We caution against performance buying on this kind of speculation. Also, tobacco bonds may face headwinds from declining consumption and potential new supply; this is not yet a buying opportunity.