Yields Seen Declining Based on 200-Year History: Muni Credit

Investors in U.S. municipal bonds should look back to James Madison’s tenure in the White House for guidance on how far tax-exempt interest rates may fall.

The $3.7 trillion market’s best annual start since 2009 drove yields to the lowest since the 1960s this year. Even at that level, they’re close to three times their trough since 1900 and just below their 200-year average, according to Janney Capital Markets.

“History shows that there is room for yields to go down,” Tom Kozlik, director of municipal credit analysis at Janney in Philadelphia, said in an interview.

A Bond Buyer index of 20-year general-obligation bonds yielded 3.86 percent yesterday, following a seven-week climb that was the steepest since 2010. The record low on the benchmark was 1.29 percent in 1946.

Looking back two centuries to the presidential administration of Madison, who was first elected in 1808, long- term municipal yields have averaged 4.65 percent, according to Kozlik. He used data from “A History of Interest Rates” by Sidney Homer and Richard Sylla for his calculation.

New England municipal bonds yielded about 5 percent the year Madison took office, according to the book.

Cash Flow

Tax-exempt mutual funds added $17.5 billion in the first 14 weeks of the year, the biggest start since 2007, according to data from JPMorgan Securities LLC and Lipper US Fund Flows. Buyers have been lured in part as eight straight quarters of rising state tax revenue signaled fiscal pressures are easing following the 18-month recession that ended in 2009.

Local debt has earned 3.15 percent in 2012 through April 25, the best start in three years and beating a 0.05 percent decline in Treasuries, according to Bank of America data tracking price changes and interest payments.

In the next two months investors will receive about $60 billion combined from interest and redemptions, almost $30 billion more than the total in March and April, according to Bank of America Merrill Lynch.

That wave of funds is chasing a dwindling supply of bonds. States and cities are set to issue $7.6 billion in the next month, down from $12.8 billion of projected sales on April 3, data compiled by Bloomberg data show.

Reinvestment Plan

Bondholders tend to reinvest coupon and maturity payments, helping push down tax-exempt yields, Ebby Gerry, who manages $14 billion as head of municipals at UBS Global Asset Management Inc. in New York, said in an interview.

“There’s a greater potential for muni yields to come down because of the increased demand,” Gerry said.

Signs of improving municipal credit quality may also add to demand. Standard & Poor’s raised the credit rating on 1.46 public-finance issuers from January through March for each one it downgraded, according to an April 24 report. That’s the first time upgrades dominated since the second quarter of 2011.

“There is a feeling that the asset class is safer than many expect,” Michael Pietronico, who manages $720 million of municipals as chief executive officer of Miller Tabak Asset Management in New York, said in a telephone interview.

Interest rates on benchmark 30-year municipals dropped to 3.32 percent yesterday, the lowest level since March 6, according to Bloomberg BVAL data. Yields on AAA tax-exempts due in 10 years were 1.9 percent.

Following are descriptions of coming sales:

ILLINOIS is set to sell $1.8 billion of general-obligation bonds as soon as May 1 to refund debt. Jefferies & Co. is the underwriter. S&P rates the state A+, fifth-highest. (Added April 27)

SEATTLE plans to borrow as soon as next week about $127 million of general-obligation bonds to refund debt, according to bond documents. The debt will price through competitive bid. S&P rates the sale AAA. (Added April 26)

To contact the reporter on this story: Michelle Kaske in New York at mkaske@bloomberg.net

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net

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