Municipals surrendered 3/8 to 1/2 point yesterday in sympathy with Treasuries after developments involving Germany and Japan knifed the U.S. dollar.
"It's Treasuries being down 1 3/8s. and the dollar got banged up, which is the reason why Treasuries went down," a municipal trader said. The 30-year Treasury bond closed down slightly more than 1 1/8 points.
Dollar bonds dropped by 1/2 point, while yields on highgrade issues weakened by three basis points, a municipal analyst said. Trading was light, he said, "but there were a lot of [bid] lists." Despite yesterday's losses, the analyst said municipals were still up on the week.
In debt futures, the September municipal contract was down 12/32 at 90 19/32. Yesterday's September MOB spread was negative 388, down from negative 398 Wednesday.
The trader said players saw a reason to take the market down when the Philadelphia Federal Reserve's prices paid index came in higher than expected, and no one saw a reason to take it back up with the dollar getting hurt.
The trader, however, said he thinks it's "ludicrous" that the market gave back all its gains on Tuesday's increase in short-term interest rates by the Federal Reserve, which many hope marks the end of the Fed's tightening campaign for some time. He said municipals are now at levels prevalent before the Fed tightening. He judged that tax-exempts were down more than the analyst did, but said the market was mainly quoted down.
"There are a lot of reasons to be constructive," the trader said. "Municipals outperformed Treasuries today, but it was still an ugly day. It's hard to imagine municipals trading up if Treasuries trade down 1 3/8 ."
Among the reasons to be constructive is the Fed's unanimous vote to raise both the federal funds and the discount rate by 50 basis points, which signals that the central bank is a serious inflation fighter.
"There are apparently no inflation doves on that panel," the trader said. That the market went lower on the Philadelphia Fed data is ludicrous, he said, because it's a reaction to a problem the Fed has already dealt with. The market should discount any troubling inflation reports that arrive in coming weeks because the Fed action has already addressed them. If bad numbers continues after that, then it's time to worry about another Fed hike, he said.
The greenback got hurt yesterday after an expected 1/4-point rate cut by the German Bundesbank failed to materialize. Adding to the woes of both Treasuries and the dollar were trade tensions between the United States and Japan. The Philadelphia Federal Reserve Bank's business conditions report also tugged at Treasuries, with the bank's business activity index rising to 13.9 in August from 11.3 in July. The report's current prices paid index climbed to 48.4 in August from 36.4 in July.
Despite yesterday's losses, better days appear to be ahead for the municipal market as long as it does not go up too far, too fast, said Robert W. Chamberlin, senior vice president and supervisory municipal analyst at Dean Witlet Reynolds Inc.
"I think everybody's a little cautious of flat out predicting that the market is going to go hog wild," Chamberlin said.
The analyst observed, however, that not enough municipal supply exists on the horizon to weaken the market. In addition, confidence is building that the domestic economy is indeed slowing. Both of those factors, together with the Fed's recent short-term interest rate rise, bode well for long-term municipal bonds, Chamberlin said.
"I think that there is some real feeling now, that yes, we are in a stronger.position, but the real test will come when we get a week with heavy volume," the analyst said. Chamberlin said this week's $700 million California deal went well in part because it "hit the market right."
While next week's new-issue calendar won't provide that test volume-wise, it does contain some noteworthy competitive deals including $1.11 million Los Angeles general obligation bonds on Tuesday, $49 million of Pennsylvania certificates of participation on Wednesday, and $88 million Atlanta various improvement bonds on Thursday.
"I think that you are going to have a good week next week as far as acceptance because they all are names that have a good following," Chamberlin said.
The analyst added that retail has a lot of cash it wants to put to work. From Dean Witter's own experience, "It has been difficult to find paper to meet demand," he said.
Meanwhile, aside from yesterday's drop, the municipal market is "doing its normal thing" of making day to day adjustments in five basis points increments.
"I think the worst thing that the market could do would be to try to come up as far as Treasuries," Chamberlin said,
"Retail will go along with very modest .price increases, but sock them with something big and we'll get stopped dead in our tracks," Chamberlin said.
Next week's biggest negotiated deal so far is $275 million Contra Costa Water District, Calif., water revenue bonds. The deal is expected to be priced through Merrill Lynch & Co.. Also next week is a $152 million New York State Mortgage Agency offering through C.S. First Boston.
In the competitive short-term note market, Texas will sell $1.7 billion tax and revenue anticipation notes on Wednesday.
Elsewhere yesterday, the price of Denver Airport bonds declined sharply as dealers sold a "rash" of securities on news of more snags in the completion of the airport project.
Players said a series of blocks of bonds came out for the bid on the heels of local reports claiming the project suffers from soil erosion.
Traders yesterday afternoon said yields on outstanding Denver Airo ports rose 25 basis points. The overall market lost 1/2 point, but Denver Airport bonds changed hands at around 8%.
The projects continued problems and the headlines they have grabbed have prompted some players to cautiously but actively scrutinize the future value of the bonds they hold.
"A lot of long bond funds have significant holdings of this paper," Richard Ciccarone, director or taxexempt fixed income research at Kemper Securities, said yesterday, "You hear about funds reducing their holdings and questions about reducing purchases. There is also a question about retail. Will Mom and Pop avoid mutual funds that own Denver just like the did with funds that owned WPPSS bonds?"
It's early yet for the Denver situation to be compared to the default of project bonds of the Washington Public Power Supply System, but Ciccarone said the ultimate fate of the Denver Airport project could have implications for the broader market.
"If the situation doesn't get cured soon we're going to hear more about it, and as it captures the attention of the popular media investors will be reminded they can get burned in this market," Ciccarone said.
In other news, the 30-day visible supply of municipal bonds yesterday totaled $2.96 billion, down $1.311 million from Wednesday. That comprises $1.32 billion of competitive bonds which is down $1.50 billion from Wednesday, and $1.63 billion of negotiated bonds, which is up $192 million from Wednesday.
Standard & Poor's Corp.'s the Blue List of municipal bonds yesterday was down $103.2 million to $1.62 billion.
