Municipal Bond Yields are “Breaking Out”

Municipal Bond Yields are “Breaking Out”

Municipal bond yields continue to “break out” as investors are (finally) coming to the realization that local governments, which lack their own printing presses, may have problems making good on their outstanding debt.  The Financial Times reports:

The sharpest swings in the muni market have been seen in the $100bn so-called “Build America bonds” – or Babs – a type of US muni debt that has characteristics similar to corporate bonds. This sector has attracted a fresh investor base, which is now demanding greater compensation for risk.

Risk premiums, or spreads on Babs relative to Treasuries, have risen to 228 basis points, according to an index from Barclays Capital. The spreads have climbed from a low of 161bp in early May to their highest level since Barclays started compiling the index last October.

Absolute yields have risen to 6.03 per cent from 5.97 per cent.“The problems in the eurozone have driven up fixed-income yields overseas – on banks, utilities and sovereigns,” said Matt Fabian, a managing director at Municipal Market Advisors. “Babs compete directly against those issuers for buyers.”

As I was discussing with our friend and regular reader JL earlier today, the muni trap is really a Catch 22 for high income earners.  On the one hand, they are about to get bent over with higher tax rates coming from Uncle Sam, as they are asked to “pay their fair share.”  So given a high tax environment, getting only higher, tax-free options like munis make sense.

But, they are certainly a gamble – you are gambling that in the event of a default, they get bailed out.  Who would buy California muni bonds today?  Only someone who was betting on a bailout.