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Munis and Treasuries Get Crazy

AUG 4, 2011 6:54pm ET
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“Flight to quality” just doesn’t capture the magnitude of the staggering rally seen in the municipal market this week. And the Treasury rally was even more colossal.

“I can’t remember the last time the Treasury market rallied like crazy and the muni market fully participated,” said George Friedlander, chief muni strategist at Citi. “Yes, we’ve lagged a bit, but participation has been pretty good … This is a really impressive rally.”

The 10-year triple-A muni yield lost 29 basis points over the last five sessions and the 30-year yield dropped 40 basis points, according to Municipal Market Data.

Those were the biggest weekly declines since December 2008. Yet the Treasury rally was so much deeper that muni-Treasury ratios actually rose over the same period. The 10-year ratio finished at 97.1% Thursday, up from 95.7% last Friday — and less than 90% on July 25. The 30-year ratio moved to 106.5% from 105.6%.

Rapid trading was dominated by institutional traders fixated on the attractive ratio trade.

“The crossover ratios just took over,” said Fred Yosca, head of trading at Bank of New York Mellon. “When you go from 90% of Treasuries to more than 100%, practically overnight, it means something. It was too compelling an argument to be ignored. Munis had to react.”

The Bond Buyer 20-bond index of 20-year general obligation bond yields dove 28 basis points in the week to 4.19%, its lowest since Nov. 4, 2010.

The 11-bond GO index of higher-grade 20-year GO yields descended 29 basis points to 3.90%, its lowest since Nov. 4, 2010. In mid-January, the index was 126 basis points higher at 5.16%.

The revenue bond index, which measures 30-year revenue bond yields, fell 11 basis points to 5.21%, its lowest since Dec. 2, 2010.

It was widely reported a month ago that summer reinvestment money was available for deployment, but much of the retail base was upset with low nominal yields and thought it best to wait for rates to rise before stepping in.

They must be kicking themselves.

“Fear kept them on the sidelines, and now fear of how bad their income-generating capability might be is pushing them in,” said Friedlander, who characterized retail participation this week as “moderate.”

“We have done a little bit of business to high-net-worth retail,” Yosca said. “It’s not retail-retail — it’s a little more sophisticated than that, it’s people that pay some attention to ratios.”

Some of the retail market is involved for a simple reason, Yosca said: What else are they going to do? Treasury yields are too low, gold is too high, and the stock market is scaring everyone.

Parking money in short-term notes is far from attractive. The Bond Buyer’s one-year note index fell one basis point to 0.29% this week, just one basis point above its all-time low in data that goes back to July 1989.

The 10-year Treasury simply shocked the market as it nosedived 52 basis points to 2.44%, its lowest end of week yield since Oct. 7, 2010. The 30-year Treasury yield went further, tumbling 59 basis points to 3.70%, its lowest since Sept. 30, 2010.

The Treasury rally was completely unexpected. MMD’s trader survey last Friday showed 100% of traders surveyed had a neutral outlook for this week.

The weekly average yield to maturity on The Bond Buyer’s 40-bond muni index, which is based on 40 long-term muni prices, was down 11 basis points this week to 5.13%.

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