Rally in Treasuries Could Lead to Arbitrageur Sell-Offs

Fine, Jacob
June 2003
Bond Buyer;6/27/2003, Vol. 344 Issue 31666, p7
Trade Publication
The U.S. Federal Reserve Board's quarter-point cut to its 1% target for the federal funds rate on June 25, 2003 could prompt selling of municipal bonds by arbitrageurs that had shorted swap rates and Treasuries. As Treasury and Bond Market Association (BMA) or London Inter Bank Offered Rate swap rates rise, making the trade less profitable, and increasing the gains to be had by unwinding the positions, they threaten to undo what has become an important source of stability for the municipal bond market in recent months. Heavy issuance of intermediate maturity bonds in 2003 has found support from arbitrage accounts that buy the bonds to collect their interest payments, enter into a contract to pay dealers fixed BMA swap rates, thus earning the difference. But swap and Treasury rates have risen following the federal cut, while municipal bond rates have remained relatively stable, eliminating the spread to be earned and driving up the value of those contracts market participants had already locked in.


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