Municipals ended unchanged to 3/8 point lower yesterday as the possibility of Federal Reserve rate increase on Tuesday began to be accorded some respect.
Former Fed governor Wayne Angell, now chief economist at Bear, Steams & Co., worried the Treasury market early yesterday with his prediction that a 50-basis-point increase in both the federal funds rate and the discount rate could emanate from Tuesday's Federal Open Market Committee meeting.
Previous market wisdom envisioned the Nov. 15 FOMC meeting as the next likely occasion for a Fed move. However, recent economic data, notably August industrial production and capacity utillization, are now considered likely to hasten the Fed's tightening schedule. Commodity and gold prices are also on the rise.
While a tightening is by no means a given for next week, one municipal trader said participants at least have to consider the possibility. "No one likes to buy when they believe the Fed may tighten as early as Please turn to MUNICIPALS page 7 next Tuesday," the trader said yesterday. "They don't want to be buying bonds and be questioned next Wednesday."
With little in the way of economic stimuli ahead near term, the market is likely to drift, and its bias will probably be lower, he said.
In yesterday's lightly traded session, dollar bonds ended unchanged, while yields on highgrade issues rose by three basis points, a municipal analyst said. Bid lists totaled $300 million or more, traders said.
In the government market, the 30-year Treasury bond ended more than 1/4 point lower to yield 7.79%. In debt futures, the December Municipal contract ended down 1/4 point at 87 17/32s. Yesterday's December MOB spread was negative 372, the same as Tuesday's.
In other news yesterday, Peter Allegrini, a managing director at Prudential Investment Advisors, told reporters he believes municipals, notably the high-yield sector, offer good value.
"I feel that, yes, rates could go a little bit higher, but this is still a good time to be buying in the municipal market because of the tremendous after-tax yield that's offered," Allegrini said during a portfolio managers roundtable sponsored by Prudential Securities Inc. He added that. "high-yield is the place to be over the next 12 months."
While municipals suffered steep price declines over the past year, rising tax rates continue to enhance their appeal, Allegrini said.
"A year and a half ago, President Clinton initiated one of the largest tax increases that we've seen in many decades," the portfolio manager said. A number of states, including Connecticut, New Jersey, Minnesota, and California, are running record deficits, he said, and have had to raise taxes to help reduce their deficits.
"Right now, states are somewhat awash in cash because of the economic expansion that we've seen, but you know the day will come again when those tax rates will not be sufficient to balance those deficits," Allegrini said.
While the media heaps attention on the federal deficit, Allegrini said that the accumulated state and local government deficit at ti-mes significantly outstrips that figure, and the day will come when states will have to again raise taxes to reduce their deficits, he said.
"It doesn't take a rocket scientist to figure out that the only way you're going to be able to do that is to raise revenues," Allegrini said. The history of politicians shows that there's really only one way to do that, and that is to raise taxes, he said.
Higher taxes make munis more attractive because no other tax shelters exist, he said.
"Everything else was eliminated in 1986 when the tax reform bill was passed," Allegrini said.
Just as higher taxes will make municipals more attractive, the supply of new municipal bonds has dropped off, Allegrini said. He noted that rising rates have dramatically reduced refundings.
"So as rates stay at these levels and the demand for municipal bonds stays basically the same or is continuing to rise, the supply of the bonds is going down," Allegrini said. "Well, that means that municipal bonds should perform. better than a lot of other fixed-income alternatives."
While he acknowledges that risks are involved, Allegrini is particularly bullish on high-yield municipals. While "there's always skeletons in everyone's
closet," high-yield municipals carry far less default risk than their taxable cousins and still return higher yields on an aftertax basis.
For instance, a typical double-B rated municipal bond yielding between 8% 1o8.5% equates to as much as a 17% after-tax yield assuming a 50% tax bracket. A comparable corporate bond yields about 12%.
"So the risk-reward, in my view, is totally out of whack when it comes to the value that's offered in high-yield bonds," Allegrini said.
Elsewhere yesterday, the 30-day visible supply of municipal bonds totaled $3.21 billion, up $54.1 million from Tuesday. That comprises $1.70 billion of competitive bonds, up $3.3 million from Tuesday, and $1.509 billion of negotiated bonds, up $50.8 billion.
Standard & Poor's Blue List of municipal bonds rose $500,000 yesterday to $1.81 billion.