The municipal market was weaker again Friday, despite more flight-to-quality gains in Treasuries, and as negotiations continued on a government bailout plan that could help stabilize the market.
"It's been such a crazy week. The muni market is down, but people just don't know what to do," a trader in Los Angeles said. "I don't think it's down that much, but the attitude is it's off, so it's off."
The Treasury market showed flight-to-quality gains Friday, following news that JPMorgan Chase & Co. will purchase the banking assets of the failed Washington Mutual. The yield on the benchmark 10-year Treasury note, which opened at 3.85%, finished at 3.84%. The yield on the two-year note finished at 2.11% after opening at 2.16%. The yield on the 30-year Treasury finished at 4.36% after opening at 4.41%.
Howard Mackey, president of the broker-dealer business unit of Rice Financial Products, said that a major reason most of the money is flowing into Treasuries right now as opposed to munis is liquidity.
"In the Treasury market, you have liquidity. And frankly, if you look at the Treasury market, it's really the front end of the curve where you have a flight to quality," he said. "The 10-year has backed off 50 basis points in the past two weeks. And we saw the 30-year get through a 4% just a few days ago, and now we're at almost 4.40%. And that's obviously because of the fear of $700 billion worth of Treasuries that will be flooding the market once this bailout passes.
"But you're seeing a real flight to quality in terms of going into Treasury bills because of the scare you had in money market funds, where stuff that was purchased after Sept. 19 may not be insured, so a lot of money came out of there, and the most natural place for it to go is in Treasury bills, and that's why you've got Treasury bills trading at less than 1%," Mackey said. "It's really fueling of a lot of uncertainty, and people [are] saying, 'I don't need to take a risk now; I can just take my money off the table. I need liquidity, and I want to make sure I can get it.' So if you put it in Treasury bills, you know that if you want to cash it in, that's easy to do. And you'll get 100 cents on the dollar."
The WaMu news is the latest in a two-week string of events that have added tremendous volatility to the markets. This follows news of Lehman Brothers' bankruptcy, the government rescues of Fannie Mae, Freddie Mac, and American International Group Inc., and the overarching $700 billion bailout plan proposal.
In the wake of all this, the new-issue market effectively ground to a halt, with a slew of issuers postponing, canceling, or dramatically reducing in size their pending transactions. According to Thomson Reuters, about $1.5 billion of bonds were priced in the new-issue market this week, despite projections of $2.4 billion.
However, despite activity in the new-issue market being at a near standstill, the secondary market is still very much functioning, with trading volume not substantially different than where it was two weeks ago, both in number and size.
Trades reported by the Municipal Securities Rulemaking Board Friday showed losses. A dealer sold to a customer Minnesota Public Facilities Authority 5s of 2027 at 5.10%, three basis points higher than where they were traded Thursday. Bonds from an interdealer trade of Washington 5s of 2031 yielded 5.36%, up two basis points from where they were sold Thursday. A dealer sold to a customer California 5s of 2033 at 5.53%, three basis points higher than where they traded Thursday.
"There is cash available in the secondary," Mackey said. "You're seeing discount buying, but you're also seeing some institutional structured bonds trade for smaller amounts, and what happens is people that have cash to buy, buy what they consider to be very cheap bonds. Because when you have high-grade municipal bonds trading at absolute higher yields than the Treasury market, then you're talking about bonds that are trading at 110% of comparable Treasuries. And unless you feel that the entire financial structure of this country is going to collapse, you're smart to make some of those purchases."
The ratio of 30-year triple-A general obligation bonds to 30-year Treasuries was 117.0% as of Thursday.
Mackey also said that the problem in the institutional market, "particularly with larger deals, is you don't have enough critical mass, in terms of buyers, to step up to be assured of getting an issue sold."
"You're seeing a reluctance on the part of underwriters in terms of being willing to step up and take underwriting risk," he said. "If you have a major firm that is having difficulty in a lot of other areas, pressure is put on all of the trading units to basically eliminate your risk. So from that standpoint, even if the muni department may have done well, if you're getting a message from senior management not to take risk, then you're going to back away from any underwriting risk. And we've witnessed that with a number of deals that have come to market over the past two weeks and then were aborted. But smart money recognizes that at some point, when the market does return to normalcy, those in hindsight will tend to be very good purchases, probably excellent purchases."
