The strong fundamentals that have been moving the bond market -- a slowdown in inflation, an extremely weak economy and an easier credit posture by the Federal Reserve -- have all been temporarily pushed aside by a massive supply of new municipal and Treasury issues. This in turn has caused a backup in interest rates, which has offered investors buying opportunities, especially in the municipal area.
The large Treasury supply is a direct result of the federal budget deficit. The main reason for the increase in the municipals is the effort by issuers to sell bearer -- or coupon -- bonds prior to the anticipated year-end registration requirements being enacted.
Through the first nine months of the year, the average monthly supply of new tax-free issues has totaled $6 billion per month. In October, the volume increased to $7.9 billion, and in November, a record $9 billion in new issues were offered.
About mid-October, a 30-year triple A general obligation issue returned 8.50 percent. Last week the yield on the 30-year bond had risen to 9.70 percent, a change of 120 basis points. The one-year maturity returned 5.00 percent in October, but has changed only slightly with a return now of 5.30 percent.
Another measure of municipal rate changes, the Bond Buyer Indices, have also given ground. The 20-year high grade general obligation index went from an 8.90 percent in October to 10.23 percent as of Thursday. Similarly, the Revenue Bond Index moved from a 9.25 percent to 10.92 percent. It is also interesting to note that the ratio of the Bond Buyer's 20-year index to the 30-year Treasury had averaged 82.1 percent from 1979 to 1982. Currently this ratio has increased to a record high of 96.5 percent (10.23 divided by 10.60). For investors in high tax brackets, this means that long-term high grade municipal bonds are cheap when compared with long Treasuries.
Consequently, if you believe the ratio will reverse itself to the 82.1 percent average because the municipals will outperform the Treasuries, then you should either purchase long-term municipals outright, or you should switch from long-term Treasuries into long-term municipals. Lower quality revenue issues are returning 11 percent or more for the yield buyers.
From the Treasury side of the market, the new issue volume has been and will be staggering. In December alone, the Treasury is expected to raise $28 billion in net new money through total sales of $51 billion of securities, including rollovers of maturing issues. In the fourth quarter, the Treasury will raise about $57 billion of new money through gross sales of $174 billion. Despite this volume, the yields on long Treasuries are lower now than in October. Conversely, T-bill yields are higher now than in October.
On Tuesday, $23 billion of HUD-backed tax-exempt project notes will be offered. They will mature monthly from April 1983 to January 1984. They should return between 4.15 and 5.50 percent.