The lowest yields in 40 years and concern over their tax-exempt status sent municipal bonds into their worst monthly decline since 2010, according to InvestmentNews (“Munis take worst pounding since Meredith Whitney”). As of December 21, municipals were on track to lose 1.9 per cent of their market value for the month. Thanks to the price decline, yields on AAA rated municipal bonds are in the 1.8% range, the highest since August, according to Bloomberg data.
The two-week sell-off is reversing a surge in muni bond buying that was apparently motivated by expectations of higher taxes after the November elections, and high-profile buying by PIMCO’s Bill Gross. In December, however, municipal bonds have fallen faster than U.S. Treasuries.
Lower yields and increased credit risk from a slow economy have been on the radar screen for some time. The impetus for this decline, however, appears to be mostly related to the possible loss of some or all of the tax exemption that municipal bond investors have enjoyed.
According to one money manager, “Municipals more or less have been a sacred cow that ? along with mortgage interest and charities ? have not been touched. If there is going to be a grand bargain, municipals may not have that status.”
Thus, municipal bond investors may end up as casualties of the fiscal cliff negotiations. If that happens, most of the casualties will be individual investors, who own approximately 70% of municipal bonds issued by U.S. state and local governments and agencies.
Investors have simply paid too much for too little yield, according to many money managers. The taxable equivalent yield for municipals is just too low.
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