Longest Winning Streak Since ’05 Shows Tax-Rise Bet: Muni Credit

U.S. state and city debt is set to outpace Treasuries for the longest stretch since 2005 on bets that tax increases will be part of lawmakers’ plans to shrink the nation’s deficit.

The $3.7 trillion municipal market has rallied each week since the Nov. 6 re-election of President Barack Obama, who wants to make top earners pay higher taxes on ordinary income, capital gains and dividends. Helping fuel the gains, U.S. muni mutual funds added $1.1 billion in the week to Nov. 21, the most since August, followed by an addition of $545 million this week, Lipper US Fund Flows data show.

Investors are also set to receive about $21 billion next month from maturing local bonds, funds they will be looking to reinvest, according to Janney Montgomery Scott LLC in Philadelphia.

“There’s a wall of cash out there right now that’s waiting for debt to come to the market,” said Michael Pietronico, who manages $860 million of munis as chief executive officer of Miller Tabak Asset Management in New York.

Obama has proposed raising the top federal tax rate on ordinary income to 39.6 percent from 35 percent. His administration is talking with congressional leaders about ways to avert more than $600 billion of spending cuts and tax increases set to start in January, in the so-called fiscal cliff.

47 Years

The surge in demand pushed muni yields to the lowest since 1965 yesterday, according to a Bond Buyer index. Munis have earned 1.8 percent this month, compared with 0.5 percent for Treasuries, Bank of America Merrill Lynch data show. Local debt has been the better bet each month since June, the longest span since February 2005.

Benchmark tax-free bonds due in 10 years yield 1.43 percent, the lowest since a Bloomberg Valuation index began in January 2009. The securities are on pace for a fifth straight week of gains, the longest since May. In comparison, Treasuries due in 2022 yielded 1.61 percent as of about 10 a.m. today in New York.

The ratio of the two interest rates fell to 86 percent last week for 10-year maturities, the lowest in 17 months, a signal that AAA munis were getting expensive relative to federal debt. For 30-year securities, the ratio fell to 91.3 percent yesterday, the lowest since July 2007.

Investors can still find yields higher than Treasuries on lower-rated munis.

More Room

Interest rates on 10-year munis rated A, Standard & Poor’s sixth-highest grade, are about 166 percent of yields on their federal counterparts, data compiled by Bloomberg show.

“It’s a pretty easy asset class to like on a relative basis,” Christine Thompson, who helps oversee about $32 billion of tax-exempts as chief investment officer for bonds at Boston-based Fidelity Investments, said in an interview. “There is room for the muni market to continue to outperform equivalent-quality debt in the taxable market.”

Investors hunting for a shelter from possible tax increases should be able to absorb a pickup in muni supply anticipated in the next few weeks, said David Frank, managing director of muni trading at CastleOak Securities LP, an investment bank in New York.

Local issuers such as the New Jersey Transportation Trust Fund, which finances roads and mass-transit projects, and the New York City Municipal Water Finance Authority plan to sell about $12 billion of long-term debt in the next 30 days, compared with a one-year average of $8.7 billion, Bloomberg data show.

‘Heavy Demand’

“They’re talking about a lot of issuance through year-end, but we’re going into a period of pretty heavy demand for munis,” Frank said. “I don’t think that rates are going to shoot up.”

Investors will be looking to buy in December before issuance drops off in January. Supply has decreased in January from December in all but one year since 2003, Bloomberg data show.

“The idea is to put the money to work as soon as possible because when the new-issue supply dries up, and it will for a period of weeks, it’s going to be a very difficult time to find bonds,” Pietronico said.

The iShares S&P National AMT-Free Municipal Bond Fund, the largest exchange-traded fund tracking munis, traded at about $114 at 10:45 a.m. today in New York, which would be the highest closing price since the fund began in September 2007.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE