While the U.S. Treasury market languished most of last week, a great deal of buying interest helped the municipal market to a strong showing. The surprising aspect about the two markets was that the Treasury was only burdened with its routine three- and six-month bill auction, while the tax-free market was deluged with new issues.
Two measures of the performance of the municipal market are the Bond Buyer's index of high-grade general obligation bonds, known as the BBI, and the Bond Buyer's Revenue Bond index, known as the Rev-dex. These two indexes are to the municipal bond market what the Dow Jones Industrial Average is to the stock market. Last week, the BBI moved from the prior week's 9.38 percent to 9.23 percent. At the same time, the Rev-dex moved from 9.73 percent to 9.58 percent.
This impressive price movement demonstrated two facts. First, it showed the underlying strength in the muni market. The fact that interest rates could decline in the face of a huge calendar is awesome, especially when Treasuries lacked direction. A strong demand existed for the new primary issues that set the pace for the rest of the market. As the new issues were scooped up, the outstanding issues, or secondary issues, also began to move as demand spilled over into their area. It takes a sizeable calendar to give a market direction, and that's what happened last week.
The second point to be made is this: There now exists for the second week in a row a 35-basis-point spread between the two indexes. That is the narrowest spread on record. The average spread during the last few years has been 80 to 85 basis points. This narrow spread means that general obligation bonds are cheap compared with the revenues. This fact in itself is startling, because 74 percent of the $17 billion in new long municipals that have been issued during the first quarter of 1983 have been revenue bonds.
A municipal specialist at Drexel Burnham believes that there are two reasons for this occurrence. First, individuals are attracted to high-yield bonds. In fact, they purchased 90 percent of all the new long munis issued in 1982. Consequently, they are attracted to the high yield found on revenue bonds. Therefore, the high grade general obligation (GO) issues are now forced to offer more yield to attract buyers.
Next, a couple of weeks ago, when the indices were separated by 68 basis points, several new GO issues Municipals' Spread Narrows came to market, but sold poorly. This necessitated lower price adjustments in order for the issues to sell out before last week's huge supply arrived. This made GOs cheaper and caused the spread to narrow to its current level.
This week will see another large muni calendar. One issue will be the $450 million State of Alabama GO issue. The high grades will have to remain cheap to sell issues of that magnitude.