Supply issues weighing on the municipal market moved to the backburner yesterday, as tax-exempt yields followed plummeting Treasuries after the Federal Open Market Committee announced plans to purchase more than a combined $1 trillion of mortgage-backed securities and longer-term Treasuries.
Though the Fed opted to hold interest rates unchanged at its 0% to 0.25% range at yesterday's monetary policy meeting, as was widely anticipated, muni and Treasury yields fell sharply when the statement was released.
In the statement, the FOMC announced that it decided "to increase the size of the Federal Reserve's balance sheet further by purchasing an additional $750 billion of agency mortgage-backed securities," and that it "decided to purchase up to $300 billion of longer-term Treasury securities over the next six months."
Traders said tax-exempt yields were lower by three to five basis points yesterday following the Fed statement's release, despite being weaker by a similar margin earlier in the session.
"We definitely got a boost from the news from the Fed," a trader in Los Angeles said. "The Treasury market is really on fire since that announcement, and we're kind of following right along now. We were struggling a bit with all the supply that's been coming, but this kind of superseded the supply issue, at least for one day."
The Treasury market, which had shown mild gains prior to the meeting, rallied heavily, with 10-year Treasury yields dropping nearly 50 basis points. The yield on the benchmark 10-year note, which opened at 3.01%, was quoted near the end of the session at 2.52%. The yield on the two-year note was quoted near the end of the session at 0.80% after opening at 1.03%. The yield on the 30-year bond, which opened at 3.83%, was quoted near the end of the session at 3.57%.
The primary market showed no signs of slowing yesterday, however.
In the new-issue market, Goldman, Sachs & Co. priced $444.5 million of mental health services facilities improvement revenue bonds for the Dormitory Authority of the State of New York. The bonds mature from 2010 through 2021, with yields ranging from 2.71% with a 3% coupon in 2011 to 5.45% with a 5.375% coupon in 2021. Bonds maturing in 2010 will be decided via sealed bid. Bonds maturing from 2011 through 2019 contain split maturities. Portions of bonds maturing from 2016 through 2019 are insured by Assured Guaranty Corp. All other bonds are uninsured. The underlying credit is rated AA-minus by Standard & Poor's and A-plus by Fitch Ratings. The bonds are callable at par in 2019.
Morgan Stanley priced $260.4 million of subordinated supply revenue bonds for Utah's Intermountain Power Agency. The bonds mature from 2010 through 2018, with yields ranging from 1.80% with a 3% coupon in 2010 to 4.70% with a 5% coupon in 2018. The credit is rated A1 by Moody's Investors Service, A-plus by Standard & Poor's, and AA-minus by Fitch.
Guy LeBas, fixed-income strategist at Janney Montgomery Scott LLC, wrote in a post-Fed meeting commentary that "even today's announcement that the Federal Reserve plans on purchasing everything in America that isn't nailed down raised relatively few eyebrows on our end."
In terms of the Fed's decision to purchase $750 billion more agency mortage-backed securities, LeBas wrote that "it's almost as if the domestic economy is on fire and the Federal Reserve is convinced that dollar bills, not water, can calm the blaze."
"This is a bit akin to Japan's original 'shock and awe' campaign designed to drag that economy out of the 1990 to 2000 doldrums, but shock and awe works only so long as consumers and investors can be shocked and awed," he wrote. "In this environment, we're not so sure that's a realistic prospect."
LeBas added that "the Treasury purchases will begin with $300 billion over the course of six months, which, not coincidentally we suspect, is roughly enough to cover the additional Treasury issuance from the fiscal stimulus package in 2009."
"Effectively, the Fed is monetizing the Treasury's debt, a strategy that appears in the encyclopedia under the heading 'how to trigger inflation,' " he wrote. "In any other environment, this monetization would be deeply troubling, but given the lack of end-user demand, the prospects for a near-term pop in prices is rather remote.
"The aggressiveness also suggests that the Federal Reserve remains highly concerned about deflation, despite the rather benign assessment in today's policy statement that, 'some risk that inflation could persist for a time below rates that best foster economic growth,' " LaBas continued. "Given this exceedingly dovish approach, and the rapid expansion of the mortgage purchase program just a few months after implementation, the risks of the Fed expanding the initial $300 billion of Treasury purchases are very great indeed. In light of this suspicion and the apparent 'Fed put' on interest rates, at this point, it's challenging to justify maintaining short positions in the interest rate markets."
As of Tuesday's close, the triple-A scale in 10 years was at 115.0% of comparable Treasuries, according to Municipal Market Data. Additionally, 30-year munis were 130.7% of comparable Treasuries. Also, as of the close Tuesday, 30-year tax-exempt AAA-rated general obligation bonds were at 144.3% of the comparable London Interbank Offered Rate.
In economic data released yesterday, the consumer price index rose 0.4% in February after a 0.3% gain in January. Economists polled by Thomson Reuters had predicted a 0.3% increase.
The CPI core climbed 0.2% in February, after a 0.2% increase the month before. Economists polled by Thomson Reuters had predicted a 0.1% uptick.
