The tax-exempt market did an about-face and ended much firmer Wednesday afternoon, after the Federal Open Market Committee announced it would make no changes to its $85 billion-a-month bond purchasing program.
Most economists had expected a $10 to $15 billion a month tapering in the purchases, which are intended to bolster the economy. Stocks and bond prices soared on the news.
The benchmark 10-year yield dropped 17 basis points to 2.68% and the 30-year yield fell nine basis points to 3.75%. The two-year yield slid five basis points to 0.33%.
Munis followed. One Chicago trader said the muni market felt three to six basis points stronger almost immediately following the FOMC meeting announcement at 2 p.m.
One New York trader focused on institutional trades in the secondary market said trading activity was very busy and prices were higher, with Treasuries.
On Wednesday, yields on the triple-A Municipal Market Data scale ended as much as seven basis points lower. The 10-year yield fell seven basis points to 2.67% and the 30-year yields fell four basis points to 4.29%. The two-year yield dropped three basis to 0.40% after trading flat at 0.43% for 44 straight session.
Yields on the Municipal Market Advisors scale ended as much as 10 basis poiints lower. The 10-year fell 8 basis points to 2.83% and the 30-year yield fell five basis points to 4.37%. The two-year closed unchanged at 0.55% for the 24th session.
In addition to maintaining its monthly purchasing program of $45 billion of longer-term Treasuries and $40 billion of mortgage-backed securities, the FOMC also decided to keep the target range for the federal funds rate at zero to 0.25%.
The FOMC also said the “asset purchases are not on a preset course, and the committee’s decisions about their pace will remain contingent on the committee’s economic outlook as well as its assessment of the likely efficacy and costs of such purchases.”
Economists were quick to react. “The payroll numbers looked a bit better in June when the Fed established a roadmap for tapering QE3 than they do today,” wrote Paul Edelstein, U.S. economist at IHS Global Insight. “Given recent developments in interest rates and fiscal policy, the committee wasn’t ready to pull the trigger. But we suspect that the bias on the committee remains against a long-lasting QE program. Barring a really bad outcome from the upcoming battles over fiscal policy in the fall and winter, we expect the Fed to taper at the December meeting.”
Guy LeBas, chief fixed income strategist for Janney Montgomery Scott, said there was a dovish tilt to the bond purchase program and to the Fed’s guidance for short-term interest rates.
“Today’s moment of truth, at which the FOMC was widely expected to announce its first reduction in the pace of quantitative easing has fallen flat,” he said. “Instead, what we have from the central bank is just one more brick in the carefully-laid wall of shifting monetary policy. Starting in January, the FOMC began discussing reductions in QE, originally for reasons of efficacy. The game of diminishing marginal returns has forced the Fed’s hand, but Bernanke simply isn’t willing to give up. Not yet, at least. That will have to wait for November.”
Economists at RDQ Economics were surprised. “Quite frankly, we are struggling to understand the logic of monetary policy outlined,” they wrote. “All of this is a clear signal that policy will be easier for longer than we were imagining and that an earlier liftoff than mid-2015 for the funds rate target seems to be very unlikely. While the bond and equity markets are celebrating the sugar rush of more prospective liquidity, we think the Fed has further complicated its ultimate exit from ultra easy monetary policy and has raised the risk of financial instability down the road.”
The Fed will wait to another three months to see how the housing market recovery holds up with higher mortgage rates before beginning to taper, said Michael Gregory, senior economist at BMO Capital Markets. “We still hold to the view that tapering will be announced at a meeting followed by the Chairman’s presser even though Bernanke indicated that the FOMC could move at any time, including intermeeting,” he said. “The waiting also allows the remnants of the sequestered spending cuts to work their way through, and also get us over the spending bill and debt ceiling humps.”
In the municipal bond market, Puerto Rico took much of the focus before the Fed meeting. Secondary traders said the market felt weaker and Puerto Rico was back in the headlines. Mutual funds continued to liquidate Puerto Rico holdings, pushing prices on some bonds into the 70 cents on the dollar range.
“I just saw Puerto Rico taxables trade at 10.10%,” a New York trader said. “It’s really busy today with Puerto Rico. Yields are all over the place.”
One CUSIP of Government Development Bank of Puerto Rico 5.5s of 2020 yielded above 10% on trades of over $100,000.
Other traders agreed that while munis are attractive on a relative basis, credits making headlines, Like Detroit, Chicago, and Puerto Rico, are worrisome.
“Yields are high enough where it’s motivating,” he said. “Buying is continuing and they are staying in on the curve. But you need to watch for the credits like Chicago and Puerto Rico.”
Trades compiled by data provider Markit showed mostly strengthening Wednesday afternoon. Yields on Ohio’s Buckeye Tobacco Settlement Financing Authority 5.75s of 2034 fell nine basis points to 8.40%.
Yields on Columbus, Ohio, 5s of 2023 slipped four basis points to 2.91% and San Antonio, Texas, 5s of 2023 fell three basis points to 2.85%.
Yields on Hawaii 5s of 2029 and New York 5s of 2021 fell one basis point each to 3.86% and 2.75%, respectively.