Tax-Free Prices Keep Rising; Cash Levels Buoy Optimism

Tax-exempts benefited from an unusually busy trading day Friday, with prices increasing about 1/8 to 1/4 point.

The activity was primarily on Wall Street. Larger dealers unloaded their own accounts into a strong market and other investment houses, eyeing another drop in interest rates, expressed interest, traders said.

"There was quite a bit of Street trading in the discount bonds," one trader said. "The [arbitrage] accounts were active because futures did better."

The December municipal futures contract chased the Treasury market higher, increasing 13/32 to close at 95.00. The MOB spread widened to negative 173 because the 30-year Treasury bond contract did even better, rising 21/32.

Secondary dollar issues gained as bidders came up to the concession offers. New Jersey Turnpike Authority 6.90s of 2014 enjoyed the best gains, increasing 1/2 point to 100 1/4-1/2, for a yield of 6.85%. East Bay California 6 1/2s of 2016 also did well, gaining 1/4 point to 98 3/4-99, for a 6.58% yield.

The insured Triborough Bridge and Tunnel Authority 6 5/8s of 2017, meanwhile, were quoted 1/8 point higher at 99 1/8-3/8 to yield 6.67%. And New York LGAC 7s of 2021 also increased 1/8 for a 99 1/2-3/4 quote, to yield 7.02%.

Municipal participants said the market appeared temporarily invulnerable: Cash levels remain high and a Federal Reserve easing is now part of the pricing. In fact, sources were more astounded by the ongoing cash levels than the pricing strength.

George Friedlander, managing director and fixed-income strategist at Smith Barney, Harris Upham & Co., attributed the cash levels to the individual sector. Although "rate shock" used to prevent individuals from dumping reinvestments into tax-exempts, he said, that psychology has now been altered and household money - via bond funds - is pouring in.

"The back of that mentality has been broken for at least a significant portion of the individual market," Mr. Friedlander said. "People are finally facing the one risk that's never been addressed - reinvestment risk - and it's creating the need to maximize returns on assets."

Hand in hand with the realization that certificates of deposit and money market funds are now performing inadequately, sources said, is the difficulty of selling the lower yields to the unconverted. One trader said the secondary market was unusually quiet most of last week because bonds were difficult to put away.

"If you are in this business, you have to get into your client's mind and adjust what his expectations are," said one trader specializing in high-yield municipals. "That's not easy."

Yield decreases were abundantly evident in a study by Delphis Hanover Corp. For the week, yields fell at least 10 basis points in the vast majority of investment-grade bonds. The biggest declines - 15 basis points - came in the 1998-2004 maturities of double-A and triple-A securities.

For the month, 20-basis-point yield declines were the norm for investment grade bonds, with the the 1998-2004 maturities again outstripping the rest, decreasing 25 basis points. For the year, similar to the Treasury market, one-year paper did the best, losing 150 to 155 basis points.

Looking forward, the market faces a quieter $1.38 billion calendar, not including New York City's $1.25 billion note sale slated for Wednesday.

Yet the lighter supply does not necessarily mean demand will drive prices still higher, according to Mr. Friedlander of Smith Barney.

"It's really tricky to figure out what happens after an avalanche of supply," Mr. Friedlander said. "Institutions are aware of the supply pockets and buy in advance of them. To say that the market will be more ebullient is a hard case to make."

In new issues, a Morgan Stanley & Co. group Friday published the formal award and pricing of the $74.89 million Illinois Civic Center bonds. The AMBAC-insured issue had a 6.65% maximum yield in the $38.38 million 2020 term maturity.

Serials were priced from a 4.5% coupon par-priced 1992 maturity out to 6.20% in 2003. All the bonds are callable at a premium in 2001, except the longest two terms - the 2011 and 2020 - which are non-callable.

Most lead managers reported lower balances on their recent new issues. Only the triple-A $94.5 million Arlington Co., Va., issue noticeably stalled. Merrill Lynch & Co. reported an unsold balance on the issue of about $14 million.

In other news, Chemical Securities Inc. announced Friday a $41 million public offering of securities backed by tax-exempt leases. The deal, for Unisys Municipal Credit Corp., is Chemical's first tax-exempt asset-backed transaction, the bank said.

The issue is rated triple-A by both Standard & Poor's Corp. and Moody's Investors Service, based on insurance from Municipal Bond Investors Assurance Corp.

The short-term market was mixed. In late trading Friday, Los Angeles notes were quoted at 4.24% bid, 4.22% offered. March New York State Trans were quoted at 5.03% bid, 5.00% offered. Pennsylvania notes were quoted at 4.34% bid, 4.32% offered. And Texas notes were quoted at 4.35% bid, 4.30% offered.

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