The municipal bond yield curve is the steepest in more than a quarter-century as investors continue to shun long-term munis in favor of short-term debt.
The 30-year, triple-A rated muni at market close yesterday yielded 5.05%, a 380-basis-point spread over the two-year, according to Municipal Market Data.
That spread, first reached Monday, was the biggest since 1982. That year, the spread reached 440 basis points, MMD said.
The municipal yield curve - which measures how steeply muni interest rates rise for bonds that take longer to mature - tracks investors' preferences along the maturity spectrum.
A flatter yield curve shows investors do not mind owning longer-term debt, whereas a steeper slope indicates disdain for longer maturities compared with short maturities.
The average spread of the 30-year over the two-year since 1980 is 213 basis points, according to MMD. Two years ago, the spread squeezed to an all-time low of 40 basis points.
The yield curve has steepened since the end of 2008 as short-term munis have rallied and bonds on the long end have not.
On the last day of 2008, the 30-year yielded 316 basis points more than the two-year. Since then, the yield on the two-year has tumbled 63 basis points, while the yield on the 30-year has barely budged.
The fattening spread expresses a relationship between two numbers: a long-term rate that has swelled and a short-term rate that has collapsed.
Short-term rates have collapsed for a series of reasons that have little to do with the municipal market itself.
The Federal Reserve has been trying to stimulate the economy by cutting interest rates. Its current target for the rates paid by banks when lending to each other overnight is a range of zero to 0.25%, the lowest ever. In addition, a worldwide flight to quality has driven cash into safe havens, yanking Treasury rates to historic lows.
This has pulled rates down on most other short-term investments because investors often compare them with Treasuries. The yield on the two-year, triple-A muni has compressed more than 150 basis points in the past three months.
Jeffery Timlin, vice president and a muni portfolio manager at Sage Financial Advisors Inc., said investors have found refuge in short-term munis, which with minimal credit risk yield 143.7% of the two-year Treasury.
The spike in rates at the long end is a bit more complicated.
Timlin explained that hedge funds and arbitrageurs earlier this decade were driving down long yields through investment strategies that entailed buying long-term municipals.
These investors tried to take advantage of what they perceived were long-term rates that were too high. Last year's credit crisis forced many of these investors into liquidation and chased away a major class of buyer for long-term munis.
Strategies like tender-option bond programs "were artificially driving down yields on the back end," Timlin said.
"Now that that particular business line is no longer really functioning, you don't have the artificial buyers at the back end that were driving down the long end and making the yield curve flatter," he said.
Guy LeBas, fixed-income strategist at Janney Montgomery Scott, agreed the primary force pushing up long-term rates is the exodus of these arbitrageurs from the market.
"The traditional staples of demand from the last couple of years have gone up in smoke," he said. "That's the effect of demand evaporation, which is more pronounced at the long end."
To a lesser extent, LeBas said credit concerns about municipalities have prompted some investors to hesitate to invest in long-term munis.
Indeed, the yield curve for troubled credits like California and Puerto Rico is about 10 basis points steeper than the curve for stronger credits like Utah, Maryland, and Delaware.
The 30-year, triple-A muni yields 80 basis points more than it did a year ago.
LeBas said he sees good value in high-quality, long-term bonds. It could take months or years for the market to recognize this value, though, he said.
"A market coming back into a more rational situation is something that takes a while," he said. "It's not a scenario that can last forever."
