Buy Side

Treasuries Swamped in Flight to Quality

As skittish investors seek out the safest possible investments to protect themselves from the financial markets' latest crisis, short-term yields in the U.S. Treasury market have plunged noticeably lower over the past week as a result of a massive flight to quality, while tax-free money market yields have increased dramatically.

Some participants said the municipal and Treasury markets haven't been this tumultuous since the credit crisis began in the third quarter of 2007 and the first quarter of 2008 when the auction-rate market collapsed. Others compared the market's current state to that of the Stock Market Crash of 1929 and the prelude to the Great Depression.

The turmoil surrounding the forced sales of Merrill, Lynch & Co. and parts of Lehman Brothers earlier this week is driving the current flight to quality in the short-term market, and is consequently contributing to the outflows in the municipal money market industry, market participants said yesterday.

Tax-exempt money market managers are selling bonds to raise cash in anticipation of additional outflows stemming from worried investors flocking toward U.S. Treasuries, in addition to cash investments, like savings accounts, and Federal Deposit Insurance Corporation-insured instruments as they continue to buffer themselves against future short-term volatility, players said.

"People are nervous about the credit of liquidity providers, so there's a little bit of market fear, coupled with funding issues at quarter end going on," said one New York short-term trader at a large firm.

"A lot of people sold stuff [Wednesday]. If that panic and fear subsides, then money could start coming back into tax-exempt money market funds," she explained. Indeed, tax-exempt money market funds suffered over the last week, experiencing outflows of $8.67 billion during the week ending Sept. 15 and joining taxable money market funds in an across-the-board asset decline, according to the Money Fund Report, a service of iMoneyNet.com of Westborough, Mass.

The 553 funds in the report ended the week with $515.45 billion in total assets, after bouncing back to positive territory last week when they gained $9.84 billion and settled at $524.12 billion.

The average seven-day yield for all municipal and tax-exempt money market funds rose by 14 basis points to 1.36% from 1.22% the prior week, while the average maturity increased to 32 days from 30 days.

The 1,309 taxable funds in the report, meanwhile, plunged by $80.71 billion to settle at $2.931 trillion, a stark difference from last week when the funds hit an all-time record high of $3.011 trillion, after netting inflows of $19.44 billion.

Overall, total money market funds assets dipped by $89.38 billion to $3.446 trillion compared with last week when they achieved a record $3.535 trillion in total assets after taking in $29.3 trillion, according to the report.

Evidence of the flight to quality is also being felt in other areas of the short-term market, such as in the pricing of variable-rate demand notes. For instance, short-term VRDNs that are reset daily saw yields spike significantly yesterday to an average of 6.84%, compared with last week when they were reset at just 2.33%, according to Thomson Reuters data.

"Until we stop seeing a 100-plus basis point rise in dailies, that fear is still around," the short-term trader added.

In addition, VRDNs that are reset weekly jumped to 5.15% yesterday after being set at 1.79% last week, according to the Securities Industry and Financial Markets Association weekly index.

"The Street is in utter chaos ... it has an apocalyptic feel to it," said another New York trader. "There is no bid. It's late February or late August 2007 all over again. Those were the last two times the world was rushing into Treasuries and munis headed in the opposite direction, and there was a complete loss of liquidity in all markets."

"It's a flight to quality like we probably haven't seen since Herbert Hoover's time," said Peter Delahunt, institutional sales manager at Raymond James & Associates Inc. in New York City.

He said investors pulling out of money market funds are scurrying into Treasury bills, which is causing those yields to drop significantly and provide more evidence of the flight to quality.

Yesterday, for instance, the U.S. Treasury auctioned $30 billion of 76-day cash management bills amid strong demand at a discount rate of 0.25%, or about five basis points cheaper than the bid coming into the auction.

The bills, which will settle today and have a final maturity on Dec. 4, came even lower than Wednesday's sale of $40 billion 35-day cash management bills, which came to market at a 0.300% high tender rate and are due Oct. 23.


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