Participants reported a somber mood in the municipal market and disappointment following rejection of the government's $700 billion rescue plan by the House yesterday.
While munis weakened, Phil Condon, managing director and portfolio manager at Deutsche Asset Management in Boston, said tax-exempts would have probably fallen even further if investors thought this was the last chance to vote on a rescue plan.
"Right now, the municipal market is very quiet. No one wants to make any decision. It's somber and people are surprised. I think people thought this would go through," he said. "But we're happy nothing is trading because if there was a lot of trading, I would be concerned about where prices would be going and which direction we would be going."
The plan was voted down 228 to 205 by the House.
Even with weakness in tax-exempts, yields in the Treasury market plunged following the House vote. Tax-exempt yields were higher by two or three basis points, but Treasuries - which had already seen sizeable gains earlier in the session following news that Citigroup Inc. will acquire the banking operations of Wachovia Corp., in a transaction facilitated by the Federal Deposit Insurance Corp. - rallied even further to double earlier gains.
The yield on the benchmark 10-year Treasury note, which opened at 3.85%, was quoted at 3.70% shortly before the failure of the bailout plan, and then finished at 3.62%. The yield on the two-year note opened at 2.10% and declined to 1.90% by mid-afternoon, before plummeting to a 1.72% finish after the vote was announced. And the 30-year Treasury bond yield, which opened at 4.38%, was at 4.23% immediately before the bailout plan vote, and then finished at 4.16%.
John Lonski, chief economist at Moody's Investors Service, said that Treasuries may continue to benefit from this news "to a limited extent."
"It may be more of the same, where most of the money searching for a safe haven parked itself in three-month T-bills, and to a lesser extent in 10-year notes, longer-term bonds," he said. "I would think that the possibility of some sort of fiscal relief would pretty much limit the downside of the 10-year Treasury for now to perhaps 3.50%."
Lonski said the market was very much in need of some evidence that the free flow of financial capital will be re-established fairly soon.
"You might end up with a rescue package that would be sufficient for the purpose of assuaging jittery financial markets," he said. "Otherwise, you will perhaps see a longer stay by elevated credit risk premia in both the municipal bond market and the corporate bond market.
"What you don't want to overlook is, the deeper the sell-off by equities, the more credit risk premia widen, the more obvious a lack of access to credit becomes, then the more likely it is that congress passes a piece of legislation that should help return normalcy to now dysfunctional capital markets," Lonski said. "Conceivably, some companies may have to start laying people off, maybe state and local governments likewise, and all of this would serve to force Congress to again vote on and pass a piece of legislation that aids stabilization."
John Mousseau, vice president and portfolio manager at Cumberland Advisors in Vineland, N.J., said he still thinks Congress "will enact some kind of stabilization package."
"I don't see them walking away from this," he said. "All you needed is a simple majority and you fell 12 votes short. Now, you have to take a crowbar and move some of these Republicans over. I think they will get a compromise done, but it may take a few days given the holiday [today]."
"In munis, there is supply pressure, liquidity pressure, and price pressure, and bonds are cheaper than a week ago - you're back up to 5.50% and the yields on intermediate and long municipals are the highest they have been in eight years," Mousseau said. "Munis are clearing at very low prices and high yields, but at least it's clearing, which is more than you can say for the mortgage market."
"It's all a matter of getting the credit markets back up and going, which means getting the trust back up and going," said Peter Delahunt, national institutional sales manager at Raymond James & Associates Inc. "It doesn't take very long to destroy trust, but it takes a long time to get it back to where you need it to be. It's not going to be a short recovery period, there's going to be a lot of medicine to take along the way, and it could be the good old-fashioned medicine, the cod-liver oil type."
Delahunt also noted that some portfolios are still in the middle of forced, but orderly, liquidations. But with little of a market around, these trades could set price levels that could impact the funds that mark their holdings to market.
"If they're the only comps around - even if they were desperation trades through a forced liquidation - they're going to impact the [net-asset value] of the assets on your books," Delahunt said. "It becomes a self-fulfilling prophecy that it could force others into more of a liquidation mode."
With the next vote likely tomorrow or Thursday, "we'll be waiting around again," Condon said.
He said the credit crisis has been "a building drama for the last 15 months and 10 days ago it became a new item. A lot of us are sympathetic, and it's hard for the taxpayers to grasp all the nuances."
Though the new-issue market is scheduled to be light again this week, in the wake of a slew of postponements amidst market turmoil the past two weeks, Merrill Lynch & Co. began retail pricing on a $300 million sale of building aid revenue bonds the New York Transitional Finance Authority.
Officials said the New York TFA sold $144 million of bonds to retail investors on the first of a three-day retail order period, selling out maturities from 2010 through 2016, from 2018 through 2021, and in 2023. The bonds are set for institutional pricing Thursday.
The bonds mature from 2010 through 2025, with term bonds in 2028, 2032, and 2038. Yields range from 3.00% priced at par in 2010 to 5.70% with a 5.625% coupon in 2038. The bonds, which are callable at par in 2018, are rated A1 by Moody's, AA-minus by Standard & Poor's, and A-plus by Fitch Ratings.
Christine Albano contributed to this column.