The tax-exempt market saw mixed trading on Thursday as all eyes focused on the Federal Open Market Committee announcement.
In the morning trading session, traders said munis were stronger, following Treasuries. But Treasuries quickly faded after the FOMC meeting announcement, and munis started to follow.
By afternoon, munis traded both up and down as Treasury prices plummeted. “Munis are wishy washy,” a New York trader said.
Trading activity was driven solely by the FOMC saying it will buy $40 billion a month of mortgage-backed securities, with no set end or total. The Fed also extended its low rate guidance to at least mid-2015.
It will continue with its “Operation Twist” program through the end of the year to extend the average maturity of its holdings, and will maintain its existing policy reinvesting principal payments from its holding of agency debt and agency MBS in agency MBS.
The majority of economists agreed QE3 will have little positive effect on the economy. “Our view is that these actions will do little to stimulate growth but will raise inflation expectations,” wrote economists at RDQ Economics. “As for other markets, we think that risk assets will get a short-term sugar rush, which will further support equity prices. Our guess is that to the extent the Fed boosts the demand for risk assets, yields will drift higher. Bernanke is marching U.S. monetary policy even further into totally uncharted territory.”
Other economists agreed. “Tying the length of the program to improvement in the labor market could add power to the punch,” said Paul Edelstein, director of financial economics at IHS Global Insight. “But our model work suggests that even if the Fed pushed mortgage rates down from current historic lows, the impact on GDP growth and unemployment would probably be imperceptible. So the Fed could end up being the sole buyer of agency MBS for quite some time.”
Michael Gregory, senior economist at BMO Capital Markets, said “the MBS purchase pace will likely increase during the months ahead, augmented by outright Treasury purchases once Operation Twist is over and we’re facing the Fiscal Cliff. MBS and the intermediate part of the Treasury curve — where banks hedge their mortgage portfolios — should outperform while the USD should underperform, as trends, for the time being.”
In reaction to QE3, Treasuries initially plummeted. The two-year jumped three basis points to 0.26% while the benchmark 10-year yield soared 11 basis points to 1.83%. The 30-year yield spiked nine basis points to 2.98%.
Edelstein said that while it seems counter intuitive for bond yields to rise after the Fed announces a bond-buying purchasing program, the yield increase makes sense as the Fed left out Treasuries in this round of QE and instead, bought riskier bonds.
Also, as inflation expectations increase with this accommodative policy, there is less demand for fixed income products. The Fed policy was also a risk-on signal more markets. “As such, money is apt to flow from bonds into risk assets such as stocks and commodities,” Edelstein said.
After the initial reaction, Treasury yields were still up, albeit less so than the initial knee-jerk reaction. For the day, the two-year yield and benchmark 10-year yield closed up two basis points each to 0.25% and 1.75%, respectively. The 30-year yield closed up six basis points to 2.95%.
After up and down trading, munis closed steady. On Thursday, the 10-year Municipal Market Data yield finished steady at 1.84% while the 30-year yield closed flat at 2.98%. The two-year closed at 0.29% for the 35th consecutive session.
In the muni primary market, Bank of America Merrill Lynch priced $158.4 million of Massachusetts Housing Finance Agency revenue bonds in two series, rated Aa3 by Moody’s Investors Service and AA-minus by Standard & Poor’s and Fitch Ratings.
Yields on the first series, $107.1 million of taxable bonds, ranged from 0.467% and 0.512% priced at par in a split 2013 maturity to 4.836% priced at par in 2043. Spreads ranged from 30 basis points to 225 basis points above the comparable Treasury yields. The bonds are callable at par in 2022.
Yields on the second series, $51.3 million of taxable bonds, ranged from 0.467% and 0.512% priced at par in a split 2013 maturity to 1.776% priced at par in 2017. Spreads ranged from 30 basis points to 110 basis points above the comparable Treasury yields.
In the secondary market, trades compiled by data provider Markit showed a mix of stronger and weaker trades. Yields on Ohio 5s of 2024 jumped four basis points to 2.26% while Triborough Bridge and Tunnel Authority 5s of 2022 increased three basis points to 2.12%.
Yields on Minnesota 3s of 2031 and California Health Facilities Financing Authority 5s of 2051 rose one basis point each to 3.25% and 3.84%, respectively.
Other trades were stronger. Yields on Florida State Board of Education 5s of 2022 dropped three basis points to 2.06% while Illinois’ Regional Transportation Authority 5s of 2021 fell one basis point to 2.32%.
Yields on California’s Golden State Tobacco Securitization Corp. 4.5s of 2027 and Dormitory Authority of the State of New York 5s of 2037 fell two basis points each to 5.88% and 3.29%, respectively.