3/27/2014

Municipal Bonds Dip in Value

Categories: Bond Trends, Innovation, Municipal Debt, Timing the Bond Market

Municipal bonds dipped in value after on March 19th Federal Reserve Chair Janet Yellen signaled that interest rates might increase in early 2015. During the question-and-answer segment of her press conference, she stated that the Fed could end its asset-purchase program in October 2014, and that it could begin increasing interest rates within six months afterwards.

The result fueled fears in the municipal bond markets of the Fed’s anticipated rise in interest rates, which triggered sell-offs in municipal bonds.

Short-term bonds were most affected. Bonds with shorter maturities climbed as much as thirty-one basis points over a five-day period, while bonds maturing on the intermediate part of curve jumped up to eleven basis points. Yields on the long end of the curve increased as much as three basis points in some cases.

Fortunately, rates finally began to stabilize on March 26th, once it became clear that the market was over-reacting to Fed comments. Bonds maturing in the 5 to 20-year range declined as much as 5 basis points.

Investors’ flight to short-term bonds began in June 2013, when then-Fed Chairman Ben Bernanke announced that the Federal Reserve planned to taper its monthly $85 million bond buying program. This demand for short-term bonds collided with a historically low issuance for the beginning of 2014. It resulted in supply-demand inequality and in turn a significant reduction in yields, which for now seems in jeopardy of being reversed.

What does this mean for the municipal issuer?

• For the year prior, Liberty had been structuring its municipal clients’ bonds with shorter terms (12 to 13 year terms vs. 15 to 20 year terms), in order to take advantage of the potential interest cost savings from what were these lower yields.

• Municipal issuers can now expect to pay higher interest rates at least in the near term, until the bond market has had an opportunity fully adjust to the Fed’s announcement. The Fed has also been known to provide additional, follow-up commentary, should markets react in what it perceives to be in an undesirable fashion.

• Municipalities may want to now consider the benefit of extending the term of their bonds in light of this change in bond term structure.

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