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Although municipal bonds have been in rally mode along with other fixed income investments, some high profile market participants think there may be plenty more to come.
While Treasury yields have fallen to historic lows as investors around the world seek safe harbor, municipal bond yields haven’t dropped to the same degree.
In a recent report, analysts told Barron’s they expect the quantity of outstanding municipal bonds to decline, fueled by state and local governments refinancing older, higher-yielding debt. This increase in activity could pressure muni yields, which, as Barron’s noted, are lofty relative to taxable benchmarks.
Muni yields have dropped about half as much as Treasuries, according to the Citi analysts cited in the report. According to their calculations, 30 year AAA-rated bonds currently yield 120% of 30 year Treasury bonds. That compares with 104.5% over the past three months.
Further, though they expect issuance to increase this year, the total supply could remain flat or actually decline if called bonds are not rolled over into new issuance.
Fewer Bonds Outstanding
Meanwhile, US states and local governments continued to pay down debt during the first quarter of this year.
According to the Federal Reserve Board, outstanding municipal debt shrank at an annual rate of 1.8%, the fourth quarterly decline in the last 15 months.
After Tax Yield is Key
Today, high-quality 30 year municipal bonds can still be purchased to yield approximately 4% tax-free. For an investor in the 35% tax bracket, that’s equivalent to a 6.15% return on a taxable bond. In stark contrast, 30 year Treasury bonds yield less than 2.70% before taxes.
Notwithstanding that we continue to caution investors against attempting to predict the direction of interest rates, the current economic environment provides a great deal of evidence that interest rates are likely to remain muted for an extended period of time.
If this is the case, we can agree with those who feel demand from income hungry investors will continue to pull down muni rates well into the future.
This report is produced solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. This report is based on information obtained from sources believed to be reliable but no independent verification has been made, nor is its accuracy or completeness guaranteed.