Municipal Bonds Storm Back

Municipal-bond yields are falling fast after hitting record highs vs. Treasury bonds on Friday.

Late last week, municipal arbitrage funds were being hit with margin calls, as their hedges were rapidly moving against them. This lead to billions of dollars in forced selling, which when pushed on the relatively illiquid municipal market, caused prices to plummet. On Friday, high-quality municipals were widely available at spreads of 100bps or more above Treasury rates. Typically, municipals yield about 80% of Treasury rates.

Initially, word on the street was that these historic levels were enticing hedge funds and other non-traditional muni buyers (even Bill Gross) to buy tax-exempt munis. This was good news and bad news, of course. The good news was that it meant that there was, indeed, capital in the system to ensure that the muni market would clear.

The bad news was that these non-traditional buyers would only be around as long as muni prices were stupid cheap. In other words, this was fast money, and fast money never sparks a persistent rally. Fast money is always looking to take its profit and get out. At best, these non-traditional buyers would merely prevent the muni market from going lower still. ...