The election results sparked a rally not just in the equity market, but in the bond market as well.
Some pundits reasoned that with the election over, the Federal Reserve would be free to ease credit further without being accused of playing politics. It was also felt that the new makeup of Congress would lead to a more pragmatic approach in dealing with the federal budget and its huge deficits. Although we have no assurance either of these events will occur, these predictions must have made sense to investors who went out and bought in the markets.
The long-term Treasury bonds jumped two points after the opening on Wednesday morning. As the entire market continued to improve, several corporate issues were quickly brought to market and sold, even though they were in competition with two issues in the Treasuries' three-part refunding. In time, the dealers pushed the Treasury market too far. The "when-issued" three-year note at one time before the auction could have been purchased to return 9.70 percent. Investors backed off from that expensive level and were able to purchase the three-year note in the auction at the average return of 9.86 percent. The bottom line was that the dealers, who were already carrying a great deal of inventory, ended up purchasing most of the new notes in the auction.
Recently, it has been costing dealers 9 to 9 3/8 percent to carry their inventory. Most of the Treasury bills are returning a lot less than this cost-of-carry rate. If the Federal Reserve fails to cut the discount rate soon, the dealers may be forced to lighten up on their inventory, which could push rates higher. This could present a good buying opportunity.
Investors who have purchased municipal bonds in 1982 more than likely have sizeable profits. Many may decide to hold their bonds because of the high tax-exempt coupons. But there are several situations that municipal buyers should be aware of.
One situation concerns the 50 or so single-family mortgage-bond issues that were sold between Aug. 31, 1981, and July 31, 1982. Most of those issues bear an interest rate cost of at least 13 percent, and most charge over 13 1/4 percent for their mortgage loan financing. This means that the issuer must pay the bondholders at least 13 percent interest, and must be able to make mortgage loans with the proceeds of the sale at 13 1/4 percent or higher. These mortgage commitments must be made within a specific period, say one year. In the event that the funds cannot be loaned out, it is stipulated in the bonds indenture that the funds not committed must be used to call in and pay off an equal amount of bonds at the price of par, or $1,000 per bond.
With VA and FHA mortgage rates now 12 3/4 percent to 13 percent, it has become impossible for the issuers to make mortgage loans at 13 1/4 percent. If mortgage rates stay below 13 percent, many issuers will be forced, in time, to call in and pay off at par those juicy 13 1/2 percent coupon housing bonds that have been selling at 10 point premiums in recent weeks. Consequently, owners of such mortage bonds should contact the brokers from whom they purchased the issues and demand that they obtain the status of the mortgage commitments of the particular issue they might own. After a thorough investigation, if the percentage loaned out is low, and the time in which the proceeds must be used is growning short, then the investor should consider selling his bonds at a premium, before they are called at par.
On Tuesday, the Treasury will sell a 30-year bond in minimum denominations of $1,000. They should return around 10.3 percent. Also on Tuesday, $2.3 billion of government backed HUD tax-exempt project notes will be offered with monthly maturities from March through December 1983. They should return 4.25 percent to 5 1/2 percent. The Commonwealth of Massachusetts will sell bonds on Tuesday, while the state of Maryland will offer bonds on Wednesday.