Bond market turmoil hits California in the pocketbook
California was forced to boost interest rates on $10 billion in short-term debt it sold Thursday, another sign of the turmoil racking the municipal bond market.
Although investor demand for longer-term munis showed signs of rebounding after plunging in the last few days, some potential buyers said they feared another wave of selling — led by individual investors shocked by their recent losses in muni bond mutual funds.
But for now, the surge in yields on many tax-free bonds “is definitely turning heads” of buyers, said Joe Lee, a muni trader at De La Rosa & Co. in Los Angeles.
The commotion over munis is part of a broader bond market upheaval triggered by investors’ sudden demand for sharply higher interest rates to buy debt of all sorts.
Analysts have blamed a confluence of factors, including a sense that interest rates had simply fallen too low. The decline had been egged on in September and October by expectations that the Federal Reserve would try to keep longer-term rates suppressed by ramping up its buying of Treasury bonds.
When the Fed finally announced a $600-billion purchase plan on Nov. 3, some investors took it as a cue to sell bonds, a shift that has fed on itself.
Buyers pulled back just as the muni market faced a huge supply of new bonds from issuers nationwide.
California on Monday set out to sell nearly $14 billion in debt by Thanksgiving, including $10 billion in short-term notes and almost $4 billion in longer-term bonds.
When it launched the note sale Monday, the state expected to pay annualized tax-free yields of 1.25% on notes maturing in May 2011 and 1.5% on those maturing in June. These “revenue anticipation notes” provide cash to help the state pay bills while awaiting tax revenue in winter and spring.
Individual investors, who typically are eager buyers of the notes each year, put in orders for $6.06 billion.
To raise the rest of the money, the state turned to big investors such as money market funds. They offered to buy $3.25 billion, but demanded higher yields. On Thursday, Treasurer Bill Lockyer bumped the yields to 1.5% on the May notes and 1.75% on the June issue.
The state was able to sell the full $10 billion only after its brokerage underwriters agreed to take about $750million of the notes.
The higher yields will cost California taxpayers $14 million more in interest expense than the state had hoped.
“The tax-exempt municipal bond market is a cold, cold world right now for issuers and taxpayers,” said Tom Dresslar, a spokesman for Lockyer.
But the jump in yields on longer-term bonds began to draw buyers back to the market Thursday. “We clearly have seen some stabilization,” said James Colby, a bond strategist at Van Eck Associates in New York.
Lockyer on Wednesday had said the state would cut back its planned sale of longer-term tax-free bonds, slated to begin Friday, to $1 billion from $1.75 billion. To make up for the shortfall, the state said it would sell more taxable muni bonds, securities popular with insurance firms and foreign buyers.
On Thursday the state said that “strong investor demand” would allow it to boost the taxable-bond sale to about $3.3 billion from the original $2 billion.
Still, the state almost certainly will pay more on the longer-term bonds — which will fund infrastructure projects — than it would have a month ago.
Investors haven’t seen this kind of whiplash in interest rates since the financial-system crash in 2008.
The yield on the Bond Buyer index of 40 long-term muni bonds, a popular industry benchmark, soared to a 15-month high of 5.51% on Wednesday, up from 4.96% two weeks earlier. On Thursday the yield held at 5.51%, indicating that buyers were back in the market.
Greater demand for bonds also was reflected in the share prices of major bond mutual funds, which must value their portfolios each day based on market prices of bonds they hold.
The share price of the $15-billion Franklin California Tax-Free Income fund, one of the largest muni bond funds, rose 3 cents, or 0.4%, to $6.85 on Thursday, the first increase since Oct. 29. The fund’s share value has slumped 4.9% since the end of October.
Rising market yields on bonds depress the value of older fixed-rate securities.
Some big investors say that though they’re tempted by higher muni yields, they’re worried that more small investors will begin to cash out of bond funds, forcing a new wave of bond sales by fund managers.
Individuals have pumped record sums into bond funds over the last two years, seeking relative safety. Now, “you’re getting a flavor of what can happen” when people find they can lose money in bonds, said Ken Naehu, head of fixed-income investing at Bel-Air Investment Advisors in L.A.