Tobacco bond holders are selling long maturities and reinvesting the new cash in higher rated securities, traders said.
The holders are selling now because the bonds' yields have fallen over the past couple weeks, meaning investors can make a profit if they unload the debt at this time. The Golden State Tobacco Securitization Corporation's California tobacco settlement finance revenue 5.75s of 2047 were trading between 7.25% and 7.27% on Wednesday, 36 to 38 basis points below the 7.63% they were trading on August 21, according to data provided by EMMA.
The trading on long-dated tobacco bonds has spiked this week because of the sell-off in Treasuries, according to a trader in New York. On Tuesday when Treasuries' yields began climbing, the Golden State Tobacco 5.75s of 2047 and the New Jersey Tobacco Settlement Financing Corporation 5s of 2041 were two of the eight most actively traded municipal bonds, according to data provided by Markit.
"Spreads have compressed a certain amount and the holders want to monetize the trade they made," a trader in New York said. "Treasury rates have stopped here so the directionality of the trade has turned, you want to get out while you can. [The increase in] selling tobacco bonds has coincided with spreads coming in."
The New Jersey Tobacco 5s of 2041 were trading from a low of 7.04% to a high on 7.14% on Wednesday, between 20 and 30 basis points lower than the 7.34% they were trading at on Wednesday, according to data provided by EMMA.
The trader in New York said the market participants selling the tobacco bonds are likely "opportunistic" hedge funds and mutual funds that bought tobacco bonds on the cheap a couple months ago.
He said that it's hard to know what hedge funds are using the proceeds from the tobacco bond sales for because, "intuitively they can look at all products, they don't have to put their money in munis."
A trader in Chicago said mutual funds that just sold tobacco bonds are probably trying to raise their funds' credit profile.
"Tobacco wound up being a good trade, and now they want to buy better, safer credits," he said. "Especially because with tobacco it's somewhat of a yield grab, and if yields are tightening you should go with the safer stuff at a similar price."
The trader in New York said he thinks upgrading is happening on the mutual fund side.
Treasuries began selling off on Tuesday after the ISM Manufacturing Index report showed its composite index rose 1.8 points to 57.1 in July, the best reading the index has shown since April 2011.
The 30-year Treasury rose by one basis point on Wednesday to 3.18%, the 10-year by one basis point to 2.43% and the two-year note held steady at 0.53%. This is 12 basis points, 10 basis points, and five basis points more than the 30-year, the 10-year and the two-year note were respectively trading on Friday.
"You might as well take profit at this time, get the cash and reinvest, hedging against the chance [tobacco] spreads on your investment could widen out again," the trader in Chicago said.
Market participants have told The Bond Buyer they believe munis' reaction to the Treasury sell-off will be muted.
Wednesday morning municipal bonds on the long end of the curve had the most dramatic reaction to the Treasury yield hike, with municipal bond yields for 29 to 30 year maturities rising from five to seven basis points, according to Municipal Market Data.
Bonds maturing in 13 to 28 years yields increased from four to six basis points, by three to five basis points for nine to 12 year maturities, and from two to four basis points for six to eight year maturities.
The three and four year maturities' yields only rose from one to three basis points, and the front end of the curve held steady.
Even though traders predict munis will only have a modest reaction to the sell-off, they have said that if Treasuries continue selling off dramatically, municipal bonds will have to adjust in price to continue being an attractive investment.
A potential cause for concern is the employment situation report scheduled for release on Friday, the trader in New York said.
"I do think [the current Treasury sell-off] is a stronger, knee jerk reaction to higher rates," he said. "If it's followed by outsized gain in employment, that could affect the market. Treasuries more than munis, munis are slow to react because some believe there are enough technicals to support market."
He said if the employment number is strong there would be more of a reaction from the municipal market next week when supply is not as low and when it is not a shortened holiday week.
A Texas Primary
The Le Porte Independent School District's $99.7 million unlimited tax school building bonds were downsized modestly from an originally scheduled $110 million, and were priced by First Southwest with yields ranging from 0.30% with a 3% coupon in 2016 to 3.13% with a 5% coupon in 2039. There is a sealed bid on the 2015 maturity and the deal has a sinking fund on the term bond in 2039.
There is an optional par call on the bonds in 2024, and the bonds are rated triple-A, based on backing from the Texas Permanent School Fund.
