Shiny tax-free yields may not dazzle buyers

By Michael Connor

MIAMI (Reuters) – Yields on U.S. municipal bonds look unusually attractive compared with Treasuries, but probably don’t sparkle enough to lift the tax-free market out of its doldrums.

After mostly sitting out a rally in Treasuries, as well as a sell-off in federal debt this week fanned by fears of global inflation, tax-free yields on 10-year AAA-rated maturities are now about 93 percent those of comparable Treasuries.

A top-quality 30-year muni yields 107 percent to that of a taxable yield on a 30-year Treasury, according to Municipal Market Data.

Three-month average ratios through Tuesday were 92.5 percent and 105.4 percent, according to MMD calculations.

“No one believes Treasuries are where they are on their own,” said Kenneth Naehu, managing director at Bel Air Investments Advisors in Los Angeles. “It’s like comparing munis to a rigged game.”

Naehu, who said he saw little, if any, buying due to fat tax-free yield ratios, said a massive intervention by the Federal Reserve in the Treasuries market was distorting long-term relationships between tax-free and Treasury yields and could not be relied on by investors.

“Normalized ratios are between 75 percent and 85 percent,” Naehu said. “The Fed has driven yields (in Treasuries) to artificial lows.”

Buying and selling in the $2.9 trillion muni market, which local governments tap to finance infrastructure such as roads, has been dominated for months by highly publicized fights over state budgets, ratings cuts and other news that has rattled the wealthy investors who hold most munis, according to Naehu.

“There is a lot of headline risk in the system,” Naehu said. “You will see more defaults. … Though it will be a small number, the number will be more than in the past. That will produce wider spreads in a market, where 75 percent of the people only have what they read to rely on.”

Other muni professionals also shrug off any benefit from rich muni yields and are distinctly gloomy, according to an MMD survey last week that showed big jumps in bearish sentiment among traders and portfolio managers.

The survey found 88 percent of traders reported themselves as bearish on munis over the next one to two months, while 67 percent of portfolio managers were bearish.

Secondary trading in munis on Wednesday was light and prices were mostly off but for some gains in short maturities, according to MMD. Treasuries fell sharply.

Yields on AAA-rated 10-year muni bonds rose 2 basis points to 3.25 percent, while 30-year yields also rose 2 basis points to 4.82 percent, according to MMD, a unit of Thomson Reuters.

(Reporting by Michael Connor; editing by Leslie Adler)

Shiny tax-free yields may not dazzle buyers