Munis Firmer as Fed Cuts Funds 75 Basis Points

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The municipal market was firmer by about five to seven basis points yesterday, after the Federal Open Market Committee slashed the federal funds rate target at least 75 basis points, to a range of 0.00% to 0.25% from its previous 1.00%.

"Back in the old days, when we saw that kind of a rate cut from the Fed, we would have yelled out, 'Freeze the inventory! We're going to mark everything up,' " a trader in Los Angeles said. "But we haven't done that - we are waiting to sell. The reaction initially was a good feeling, with everyone talking it up, but I haven't really heard of a lot of trades."

"We're showing paper on the Street, but there's really no one coming in to buy it up," the trader said. "It's actually quiet. It's kind of eerie. It's firmer out there, by at least five basis points, but it's quiet. It's usually a delayed reaction, though, so maybe tomorrow morning people will be jamming in here to buy bonds."

In the new-issue market yesterday, Illinois competitively sold $1.4 billion of general obligation certificates in three tranches, all to JPMorgan. Notes from the $600 million series due May 25 were sold with a true interest cost of 3.99%, and yield 3.98% with a 4.5% coupon. Notes from the $400 million series due April 24 were sold with a TIC of 3.81%, and yield 3.80% with a 4.5% coupon. And notes from the $400 million series due June 24 were sold with a TIC of 4.19%, and yield 4.19% with a 4.5% coupon.

With few orders from funds ahead of the 11 a.m. Central Time bidding, broker-dealers held back, market participants said. Sources said some broker-dealers were soliciting fund interest for yields as high as 6 to 7%.

JPMorgan's James Lansing, a managing director in the tax-exempt capital markets group, said the firm submitted its bid without any orders in hand, a move he hopes sends a message of the firm's capital commitment to issuers.

"This is an example of JPMorgan's ability to provide liquidity to municipal issuers during this period of market dislocation," Lansing said. The firm has placed most of the securities at a profit, although he declined to provide more information.

The sale was originally scheduled for last Thursday, but officials on Wednesday postponed it after Gov. Rod Blagojevich was arrested on corruption charges, and as of late last week the deal was still awaiting final approval of transaction documents from some officials, including the Illinois attorney general.

Standard & Poor's put the state's AA rating on CreditWatch negative based on concern over its ability to handle its budgetary shortfall - a projected $2 billion for the current fiscal year - considering the legal charges facing the recently arrested governor and his chief of staff.

Moody's Investors Service rates Illinois' GOs Aa3 and Fitch Ratings rates them AA-minus.

In a written comment reacting to the Fed decision, Guy LeBas, fixed-income strategist at Janney Montgomery Scott, wrote that yesterday's "cut in interest rates marks an effort to support the economy in a time of extreme stress and when deflation has become the main price concern."

"Though neither of these issues are exactly breaking news, dealing with the combination is something policymakers have little experience in dealing with," he wrote. "Moreover, the Fed is running out of room to enact policy actions with its traditional tool, the fed funds target rate.

"Zero has been on the horizon for several months now, and, now that [chairman Ben] Bernanke and the Federal Reserve have largely expended their ability to manage liquidity through interest rates, alternative policy action is virtually all that's left in the Fed's quiver of arrows," LeBas added. "Given the continued weakening in economic conditions along with fears of a protracted deflationary environment, protecting what's left in that quiver and deploying it only when necessary needs to be the primary focus of the Fed's decision making until Jan. 28."

Tony Crescenzi, chairman of Miller Tabak Asset Management, wrote in his Fed decision comment that the FOMC "took dramatic steps today to combat the financial and economic crisis, meeting hopes on two key fronts and putting an exclamation point on its efforts with two others."

According to Crescenzi, the two "most important features of the Fed's policy statement" were that the Fed "reinforced the theme of 'low for longer' " and that the FOMC "indicated it would purchase 'large quantities of agency debt and mortgage-backed securities,' adding that it 'stands ready to expand its purchases.' "

In the accompanying statement, the FOMC wrote that "weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time."

"The focus of the committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level," the statement said.

Additionally, the statement noted that the Fed "will continue to consider ways of using its balance sheet to further support credit markets and economic activity."

LeBas wrote that the "policy statement accompanying today's rate cut contained an acknowledgment of many of the common-sense issues facing the economy today."

"Consumer spending continues to weaken, the housing markets are stagnant at best, and credit is very much unavailable to many of the corporations and consumers that need it to work through current pressures," he wrote. "Inflation, meanwhile, is a back-burner issue at most, and the strength of the financial system remains a concern. Aside from the unusual interest rate 'range,' the Fed's statement noted in no uncertain terms that 'conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.' "

"We read that to mean that Bernanke will sustain the fed funds target at this low level at least through the middle of 2009 and likely even longer," LeBas said. "In the meantime, the types of alternative policy actions we've discussed are likely to receive greater headlines. Specifically, the FOMC statement mentioned that it plans to enact 'measures that sustain the size of the Federal Reserve's balance sheet at a high level,' meaning a probable deepening of already-announced purchases in the mortgage, agency, commercial paper, and asset backed security markets."

The Treasury market showed sizeable gains following the Fed decision yesterday. The yield on the benchmark 10-year Treasury note, which opened at 2.51%, finished at 2.29%. The yield on the two-year note was quoted near the end of the session at 0.65% after opening at 0.74%. The yield on the 30-year bond, which opened at 2.95%, was quoted near the end of the session at 2.80%.

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