That explosion you heard last week was the bond market going into outer space. Prices rose with a vengeance. New issues were sought after and quickly sold out. And buyers just as eagerly pounced upon secondary market merchandise.
The reasons for this dynamic move were more technical in nature than fundamental. This was a time of very little inventory on dealers' shelves due to the high cost of inventorying bonds. Dealers carry their bonds in one of two ways: They may use a dealers loan with a bank (current rate is 19 to 20 percent), but the more widely used way is through a repurchase agreement with an institutional customer. The customer loans the dealer money at a fixed rate of interest, and the dealer puts up his inventory as collateral for the loan.
On March 25, the "repo rate" the dealer pays the customer was 14 percent. Since the dealer loan rate at a bank was 18.5 percent, the repurchase agreement was preferable. With some corporate bonds having coupons of 14 percent or higher, the dealers either broke even or made the difference if the coupon was higher than 14 percent.
If a dealer bank had a tax-exempt bond in inventory, they benefited from the tax exemption. If the bond had a 9 percent coupon, the taxable equivalent for the bank would be 17.59 percent. So it paid a dealer bank to carry high coupon quality tax exempts in inventory.
However, by April 8 the "repo rate" had risen to 18.50 percent and the dealer loans at banks to 19.5 percent. With the cost so high, it made sense to carry the high couponed tax exempts or merchandise that could be moved quickly. As a result, inventories were nil.
The trigger for this "spring rally" (or "bear market rally," if you will) was the silver fiasco engineered by the Hunt brothers. It caused a shift to quality -- that is, a move into Treasuries, especially short bills. As short rates fell, the effect spilled over into the longer maturities. Finally last week, as news of a weakening economy was released, the market thought 'recession' and the explosion was on.
Since the rally began, long Treasuries have advanced more than 8 points, while six-month Treasury bills have declined more than 140 basis points (a basis point is 1/100th of a percentage point). Since only municipal dealers owned high grade bonds, the tax exempt rally was confined mainly to quality issues such as those sold by the states of Oregon and Connecticut. These bonds went from dealer to dealer and each time at a higher price. In a trading frenzy, some of these longer bonds advanced 10 to 12 points. Accordingly, long utility bonds moved up 8 points, too.
New tax exempt issues were repriced with lower returns or increased in size, and still sold out. Housing bonds, however, did not participate in the move because of the continued heavy volume of new issues. Long North Carolina Power bonds were priced to return 10.5 percent. Two 3-year pollution control issues were repriced to higher levels and returned 9 and 9.25 percent.
However, this rally has been overdone, and until more volume comes into the marketplace to test these lofty levels, the question of whether rates have peaked will be a moot one. Prices may not go back to their lows of the last two months, but a correction will occur. That would be the time to commit more funds and not chase the market in its present state.
An offering will be made this week of $1.2 billion tax exempt project notes that are backed by the Department of Housing and Urban Development. They will have maturities of 6, 9 and 12 months and will come in minimums of $25,000. Three weeks ago, a similar issue returned 8.75 percent. The price talk on the new issue is 8 percent in the 9-month area and 7.80 percent in 12 months. The New York State TRAN issue is still in limbo.
For buyers of Virginia tax exempts, Richmond will offer $28 million general obligation bonds Wednesday. They will mature serially from 1981 through 1998 and will carry an AA rating.