Big changes in the muni bond market should prompt some individual investors to rethink their position.
To understand the source of this upheaval, look no further than the tax overhaul signed into law almost two years ago.
Big banks dive back in
Large institutions, once among the biggest buyers of munis, began pulling out of the market after the law was passed. The measure slashed corporate tax rates, taking the shine off munis.
Lately, though, they’ve reversed course. Among the top 10 banks, there was a net injection last quarter of almost $1 billion into the tax-free market, according to Bloomberg. Four banks – Citigroup Inc., Goldman Sachs, First Republic Bank and Wells Fargo & Co. – led the way.
Analysts say the U-turn stems from lower yields among other fixed-income securities as well as another byproduct of the tax law: A spike in the issuance of taxable bonds.
More changes in the muni bond market
As we noted (“Looming Tax Law Fuels Municipal Bond Rush”), the law removed the tax exemption on advance refunding bonds. Advance refundings enable issuers to refinance their debt and lower their borrowing costs. It’s widely regarded as an ideal way for state and local governments to take advantage of favorable interest rates.
While the new law initially curbed the issuance of traditional advance refunding bonds, issuers are now turning to taxable advance refunding bonds, and buyers have embraced them.
Taxable issuance reached $53.9 billion as of mid-November, about 80% above taxable muni and corporate-backed debt sold last year, according to Bloomberg.
Pressure on supply
As taxable issuance surges and institutional demand increases, there’s also significant interest from overseas investors. With negative interest rates in many countries, foreign residents are pouring cash into the market. As of the second quarter of 2019, they hold $102 billion in municipal bonds.
Yes, a record number of investors who can’t benefit from the tax-free nature of munis still find them attractive.
Reticent investors should rethink their position
What does this all add up to? It’s simple: Demand is soaring and supply is easing.
Individual investors have always appreciated municipal bonds for their security and steady stream of tax-free income. Changes in the complexion of the market and the investing habits of big players don’t alter their thinking.
However, those trying to time the market, waiting for innumerable and unpredictable economic factors to line up before committing their investment dollars, will find no solace in the shifting sands and should rethink their position.
