The tax-exempt market sold off, following Treasuries, in reaction to Federal Reserve Chairman Ben Bernanke’s comments following the Federal Open Market Committee meeting that suggested the Fed may start tapering its $85 billion-a-month bond purchasing program by the end of the year.
In a press conference Wednesday afternoon, Bernanke said the committee could start tapering by the end of 2013 and finish by mid-2014. Stock markets and Treasuries sold off, and munis followed.
The Dow Jones Industrial Average fell 205.5 points, or 1.34%, to 15,112.73. The Standard & Poor’s 500 index dropped 22.88 points, or 1.39%, to 1,628.93. The Nasdaq fell 38.98 points, or 1.12%, to 3,443.20.
Treasuries ended much lower. The two-year yield increased four basis points to 0.31% and the five-year yield spiked up 17 basis points to 1.23%. The benchmark 10-year yield jumped 14 basis points to 2.33% and the 30-year yield climbed six basis points to 3.41%.
Munis followed Treasuries. Yields on the Municipal Market Data scale ended as much as five basis points higher. The 10-year yield increased four basis point to 2.28% and the 30-year yield rose five basis points to 3.58%. The two-year yield rose one basis point to 0.32%.
Yields on the Municipal Market Advisors 5% scale closed as much as six basis points higher. The 10-year and 30-year yields rose five basis points each to 2.39% and 3.69%, respectively. The two-year was steady at 0.39% for the second session.
The Fed also said the committee is “prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes.” The FOMC also decided to keep the target range for the federal funds rate at zero to 0.25% and said it currently anticipates that exceptionally low levels for the federal funds rate will likely be warranted as long as the unemployment rate remains above 6.5% and inflation is projected to be no more than 2.5%.
The Fed said labor market conditions have shown some improvement in recent months, but that the unemployment rate remains elevated. Most board members expected monetary tightening to start in 2015 with GDP growth substantially stronger and unemployment as low as 5.8%, according to the Fed’s latest summary of economic projections.
“The Fed noted that information received since the FOMC met in May suggests that economic activity has been expanding at a moderate pace,” economists at RDQ Economics wrote. “The most significant change in the policy statement was on risks to the outlook. The Fed said the committee sees the downside risks to the outlook for the economy and the labor market as having diminished since the fall.”
“In our view, this statement sets the Fed up to dial back the pace of bond purchases and signals that the Fed sees itself as less likely to be on hold at 0% to 0.25% when mid-2015 rolls around,” the economists added. “Bernanke acknowledged in his opening to the press conference that the Fed may moderate the pace of purchases later in the year and said the Fed may end purchases by mid-2014. However, the Chairman said there would be a considerable period between ending purchases and beginning to hike rates. Our best guess is that tapering begins at the September FOMC meeting and the purchases are wound up sometime during the second quarter of 2014. We expect the Fed will first hike rates at the beginning of 2015 rather than in mid-2015.”
Other economists were not as optimistic. “The Fed sent more tapering signals than we anticipated for this meeting,” wrote Paul Edelstein, director of financial economics at IHS Global Insight. “But we maintain that the Fed is too optimistic on unemployment, and continue to believe that it won’t taper until 2014. Of course, this view is predicated on progress in the labor market. If the unemployment rate declines enough over the summer, we would likely expect a tapering as early as September. In any case, we are still a long way off from a rise in interest rates.”
Traders in the muni market were focused on selling and unloading inventory. “We have some stuff that we are looking to sell but I don’t think there is anything big until after the Fed announcement,” a San Francisco trader said Wednesday early afternoon. “It’s been so weak over the last few days that dealers are trying to get light on inventory and are not buying.”
This trader said the market has stabilized but there is not much of a bid side. The bid-ask spread is wide.
“From the buying front, we are looking at the secondary and picking spots but we haven’t had a ton of success. We hope it’s weaker after the Fed.”
Traders were focused on the short end of the curve. “Retail and institutional trades are seeing more activity today,” a New York trader said. “They are actively trading mostly short stuff inside five and six years.”
In the primary market, RBC Capital Markets priced for retail $332.7 million of New York’s Metropolitan Transportation Authority revenue bonds, rated A2 by Moody’s Investors Service and A by Standard & Poor’s and Fitch Ratings. Institutional pricing is expected Thursday.
Yields ranged from 0.39% with a 4% coupon in 2014 to 4.41% with a 5.25% coupon in 2043. Bonds maturing in 2013 were offered via sealed bid. The bonds are callable at par in 2023 except those maturing in 2027 and 2033 which are callable at par in 2018.
In the secondary market, trades compiled by data provider Markit showed a mix of strengthening and weakening.
Yields on California’s Golden State Tobacco Securitization Corp. 5.125s of 2047 rose five basis points to 6.58% and New York State Thruway Authority 5s of 2029 increased four basis points to 3.43%. The Los Angeles Department of Water and Power 5s of 2022 increased two basis points to 2.43%.
Other trades were stronger. Yields on Massachusetts Water Pollution Abatement Trust 5s of 2021 and Puerto Rico Sales Tax Financing Corp. 5s of 2043 fell three basis points each to 1.92% and 5.07%, respectively.
Yields on Miami-Dade County, Fla., 5s of 2035 dropped three basis points to 4.39% and New Jersey Turnpike Authority 5.5s of 2025 slipped one basis point to 3.22%.
