Municipal bonds may be sailing into the “perfect storm.” Municipal bonds and bond funds have declined rather sharply in recent days. While these investments have been considered very low risk in the past, a number of factors have combined increase their risk and to drive yields up and prices down. Those factors include a large supply of new issues, the looming fiscal cliff and politicians’ talk about limiting the tax exemption enjoyed by municipal bond holders, and rising interest rates.
The iShares National AMT-Free Muni Bond ETF sustained a decline of approximately 2.5% in a few days. That fund is a significant barometer because it tracks the entire market for U. S. investment grade municipal bonds (“Stars aligning against munis at year end,” by Dan Jamieson, InvestmentNews).
Another factor in the recent decline is what some have called a bubble in the municipal bond market. Municipal bond prices fall as interest rates rise. It does not take any imagination to foresee that the combination of a bubble in municipal bond prices and rising interest rates has the potential to produce some significant losses. Municipal bond holders are generally defensive investors who are unwilling to assume that kind of risk.
Page Perry is an Atlanta-based law firm with over 150 years of collective experience maintaining integrity in the investment markets and protecting investor rights.