Just as the dust was setting from a municipal yearend borrowing binge, the Federal Reserve Friday sent the tax-exempt market into a frenzy by lopping a percentage point from the discount rate.
Municipal bonds gained roughly 1/2 point on the day, and more striking gains were reported in the municipal note market.
Traders had expected a cut, but not a full percentage point. The decisive action by the Fed, lowering the discount rate to 3.5% from 4.5%, jolted the secondary market.
"There's a bid for everything out here," a Philadelphia-based bond trader reported Friday morning. "The feeling is that the market's got a lot of room to move. Treasuries are cheap and municipals are even cheaper."
With few new deals being priced in the primary Friday, secondary market traders were shooting in the dark, one said.
"How much does it take to buy a loan? Right now you just don't know," he said, adding that new negotiated deals will have to be priced for the market to reach a consensus on the Fred's Christmas cut.
Nevertheless, Friday's trading was heavy, with a variety of names changing hands. Florida general obligation 6.40%s of 2012 reportedly traded at 6.45%. At that level, the double-A bonds had posted a striking 1 1/8 points improvement for the day, according to one market analyst.
"If it's indicative of the market, it means that the long high-grade market has been bumped up 10 basis points. It's a remarkably good price," the analyst said.
In other secondary activity, Shelby County, Tenn., bonds maturing from 2005 through 2009 were also reported trading. by midday, North Carolina Eastern 6 1/2s of 2017 were quoted up 1/4 point of 97 3/4-98 1/2, where they yielded 6.68%.
In the dollar bond market, Denver Airport 7 3/4s of 2021, were offered at 98 1/2-99, yielding 7.88% and up 1/2 point from the 98-1/2 they traded at Thursday. Port Authority of New York and New Jersey 6 1/2 of 2021 AMT bonds changed hands at 97 1/2-98 1/4, up 1/2 point from Thursday, to yield 6.69%. Pennsylvania Turnpike Authority 6 1/2s of 2013 were quoted at 99-1/2, up 1/2 point on the bid side to yield 6.58%.
The short end of the municipal market reacted most violently to the discount rate cut.
California Rans and other top-grade notes improved about 25 basis points from Thursday. By late in Friday's session, the notes were offered at a yield of 2.95%, with bids at 3.00%. New York City Rans maturing in June were traded at 4.50% Friday.
Today's opening bids for March New York State Trans should be around 3.95%, meaning investors are willing to accept 90 fewer basis points in yield than they were on Wednesday, when bids were at 4.85%.
Besides the discount rate cut, another factor is forcing New York March note yields down: Some $905 million of the state's notes mature Dec. 30, and market players are scrambling to sell the expiring notes and take position in others.
One trader wondered just how much lower the Fed will be able to cut short-term rates before municipal money market investors bolt from short-term securities and venture out along the curve in search of better yields. "If this move doesn't do it, I don't know what will," he said.
Primary market activity last week totaled $2.82 billion, including $403.8 million of competitive offerings and $2.11 billion of negotiated deals. Short-term issuance totaled $301.8 million.
On Friday, issuance was light. The City of Virginia Beach Development Authority sold $70 million through a Goldman, Sachs & Co. syndicate. The deal was repriced and restructed late Friday to yield from 3.90% in November 1992 maturity out to 6.65% in a 2021 term bond.
Dealers continued to find permanent homes for their holdings as the year's end loomed. The Blue List of dealer inventory fell $66 million Friday, to $1.16 billion, a 1991 low.
The 30-day visible supply totaled a mere $220 million, including $157 million of competitive offerings and $63.2 million coming to market by negotiation. With the $1 billion New York City deal and the $247 million of Union County, N.J., bonds no longer on the horizon, negotiated supply fell $1.16 billion Friday from earlier in the week.
This week's estimated volume includes only $37.4 million of short-term issuance. That would leave total municipal issuance for the year at just slightly more than $154.47 billion.
In the debt futures market, the March municipal contract settled up 25.32 at 96 13/32. The MOB spread widened slightly, to negative 202 Friday from negative 200 Thursday.