Fixed-Income Market Commentary Archive

March 2009

February Fixed-Income Review

• The slide in Treasury bond prices continued in February as every part of the Treasury index was in negative territory at month end. The hardest hit was the long end - again. The 20-year + component was down another 1.5%. YTD it is now down 14.4% while the entire index is down 3.4%. The benchmark 10-year Treasury was down 1.3% for the month and is down 5.8% YTD. Why such negative action if investors are still in the flight to quality mode? It is, at least in part, due to the realization that the tidal wave of new issuance will continue unabated for some time to come. Throw in some legitimate inflation concerns and then consider the size of borrowing away from the government (high-grade, better yielding corporate bonds and FDIC guaranteed financials) and you have much of your explanation. We do see some big one-day swings in each direction in response to headline events, but the overall direction is clear. The volatility in Treasuries is evident when we see that over the past three months we have had 15 trading day moves of 1% or more in the 10-year. That compares to just six such moves in less extreme times, such as all of 2006 and 2007.

• February was an interesting month for the municipal bond market and a handful of headlines grabbed our attention. Among them, the State of CA passed a budget (good, but they'll likely be back in a similar spot next year). The stimulus / spending bill passed and all states will be receiving some level of "free" money from it. A report from Standard and Poor's refers to the widening gap between assets and liabilities in state pension funds and the pressure it could add to the ratings of those states. One of the lesser covered headlines involves municipal bond insurance. Insurer MBIA is splitting its business into two. One component will have the liabilities of the insurer's municipal bond insurance business (the good) while the other will have the liabilities of the mortgage bonds / structured products liabilities (the bad and the ugly). Moody's, the rating company, will review the muni insurer business and has them listed as possibly receiving an "upgrade" in their rating status. A lot still has to occur here, but at least the first steps have been taken.

• The municipal auction rate securities market collapse is now one year old and although some investors have "gotten out" of their positions, many more remain holding illiquid securities. The market initially saw significant amounts of refinancing occur when the short term rates on these securities climbed above the rates the issuers would have to pay on more traditionally structured long-term bond deals. Now that rates on some of these securities are sharply lower, the underlying issuers have no incentive to refinance that debt. About 40% or $85B municipal resets remain outstanding according to one source. Unfortunately this chapter is not over yet.

• Taxes, taxes, taxes. There seem to be a lot of new tax initiatives playing out around the country right now and some are sure to help raise the appeal of tax-exempt municipal bonds. Higher taxes are not exactly a surprise and it appears that the only area of the economy that can get away with raising the cost of "goods and services" during tough economic times is government itself. Proposals are being discussed that could result in significant changes to the tax system, some of which include a reduced level of the allowable amounts on deductions from previously sacrosanct items such as mortgage interest and donations to charity. The State of NY wants to start taxing skiers for lift tickets and lessons, California now has a top state tax rate of 10.55% and my own home state of Massachusetts is itching to have the highest gasoline taxes in the country of 42¢ per gallon. There is a lot more going on, but I think you get the picture. Munis are not going to help you avoid all forms of taxation of course, but they do offer a safe haven from some. Recent conversations with some clients have led them to increasing their allocation to the asset class or initiating a position. By the way – have you ever wondered why line 8b is included on your IRS Form 1040?

Christopher Keith
Fixed-Income Manager