“The gainsays in the market appear to be winning out over the positives,” said Peter Hayes, forestall of the Municipal Group at BlackRock. “We’re a bit cautious in the near term and expect the deal in to be in a discovery mode over the next two months.”
The market needs to originate two things: how far and how fast interest rates will rise, given the tireless economy, and what effects tax reform will have on the supply and marketability for tax-exempt bonds.
On the first front, the 40-basis-point rise in the 10-year Resources bond yield since the beginning of the year has been tough on muni engagements, as well.
“Interest rates have hurt the market,” said Tom Hession, muddle through partner of Riverbend Capital Advisors. Hession focuses exclusively on metropolitan bonds and acts as a subadvisor for separately managed accounts.
“People see censures going up and they sell,” he said.
So far, muni bonds virtually father tracked the move in Treasurys. While the rise in rates has begun to out, more signs of a strong economy — particularly wage inflation — could talk someone into something the Federal Reserve Board to move more quickly than assumed in raising short-term rates. That in turn could push longer amounts up further.
“We’re certainly moving in the direction of higher rates,” said Hayes at BlackRock.
When it obtains to the Tax Cuts and Jobs Act passed by Congress last year, the effect on the muni covenant market is even less certain. On the one hand, the bill did not touch the tax immunity for interest income from municipal bonds, as many feared. Nor did it exclude private-activity ties from favorable tax treatment. States and municipalities use such bonds to wealth specific infrastructure projects. Roughly $30 billion in private-activity cohere issuance was pulled forward into December due to fears about the tax folding money.
However, for many people with hefty state and local tax bills, the new federal tax law gives municipal bonds some appeal. The new law caps the state and local tax removal that can be claimed on federal returns at $10,000. For many households, that cap purposefulness outweigh any potential benefits from other changes in the law.
For these people, tax-free investment receipts (like muni bonds) becomes quite valuable. Industry experts apprise that despite the appeal of municipal bonds, investors need to be wary because the municipal bond market can be complicated.
Other elements of the correction bill, however, could adversely impact longer-term demand for tax-exempt muni treaties. The bill disallowed the common practice of advance refunding, which enabled metropolises to lower their costs by refinancing debt at lower rates.
Hession spoke that advance refunding had accounted for approximately 15 percent of muni restraints issuance over the last 10 years.
“It’s like refinancing a mortgage,” about Hession of Riverbend Capital Advisors. “The bill eliminates the ability of [towns] to issue new debt to retire older deals and save money.” With significance rates on the rise, however, these refinancing moves would plausible diminish, anyway.
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Lower tax rates could also upset demand for muni bonds. With lower marginal tax rates, tax-free profits is relatively less valuable. The lowering of the top bracket to 37 percent, from 39.6 percent, may pare down demand slightly in the high-net-worth market segment, but most analysts credence in the impact will be muted.
“The need for income hasn’t changed for retail investors and retirees,” conveyed Hayes at BlackRock, which currently manages $129 billion in its muni thongs funds. “People also see municipal bonds as a safe investment.”
The fluctuates on the corporate side of the demand equation, however, could have a bigger smash. With the corporate tax rate reduced to 20 percent, down from 35 percent, both Hayes at BlackRock and Hession of Riverbend Paramount Advisors expect the banks and insurance companies that make up nearly 30 percent of the market will now have less interest in tax-free checks.
“We’ll likely see diminished appetite for tax-free bonds on the institutional side,” alleged Hession. “There will still be interest in munis from hospitals, but this will impact demand.”
Hayes at BlackRock said there is already hint that banks and insurance companies are reallocating assets from council to investment-grade bonds.
One potentially mitigating factor is an increase in demand for munis in high-tax forms such as New York and California. Because the tax bill capped the deductibility of maintain and local income taxes at $10,000 per individual, taxpayers in those confirms will be looking to maximize other deductions and minimize taxable gains. Municipal bonds in those states already have been outperforming the furnish.
What do all these countervailing forces mean for the muni market attitude? “It’s been such a volatile start to the year, and it’s very hard to say how modulations to tax rates will play out,” said Riverbend’s Hession. “Yields are innumerable attractive than they’ve been in a long time, so if someone is easy with a more volatile environment, this could be a good moment to consider municipal bonds.”
Jon Yankee, co-founder of registered investment advisor FJY Economic, hasn’t lost his confidence in the municipal market.
“Municipal bonds are silence an important part of most of our clients’ investments,” he said. “Their energy purpose is to provide stability for a portfolio.”
He prefers, however, to outsource the job to a foreman focused solely on the muni market.
“We do financial planning, and investment governance is a piece of that, but we outsource [municipal bond investments] to experts,” required Yankee.
Indeed, the days of investing in a municipal bond and rolling it above into a new one when it matures are over. With the demise of the bond warranty industry in the financial crisis, credit quality in the market has become a much bigger bother for investors — one big reason mutual funds and ETFs have become a far profuse attractive option. With thousands of issuers in the market having exceptionally different financial profiles, analysis has become too big a job for financial advisors, let unequalled individual investors.
“It’s a tough market to dabble in,” said Riverbend’s Hession. “It’s impressive to be engaged at all times.”
— By Andrew Osterland, special to CNBC.com