Yields in the $3.7 trillion municipal market are the lowest in 11 months amid the most demand for tax-exempt state and local debt since January 2013.
The rally drove the largest exchange-traded muni fund to the highest level in almost a year. The $3.22 billion iShares National AMT-Free Muni Bond ETF climbed to $108.40 per share, the highest since May 30, data compiled by Bloomberg show. Benchmark 10-year bonds yield 2.34 percent, the lowest since June. Yields move inversely to prices.
Individuals added $943 million to muni mutual funds in the past week, the most in 16 months, Lipper US Fund Flows data show. The rally runs counter to expectations that interest rates would rise as the economy strengthens. Muni returns in 2014 have been driven by the fewest sales in three years, and have outpaced those on stocks, Treasuries and corporate securities.
“High-grade munis is a momentum sector,” said Vikram Rai, a fixed-income strategist at Citigroup Inc. in New York. “It’s not cheap by any standard.”
Analysts at the bank, who correctly predicted the 2014 rally, have said the gains are near an end.
Munis have gained about 5.5 percent this year through May 7, Bank of America Merrill Lynch data show. Treasuries have earned 2.6 percent and corporate debt 4.7 percent. Including dividends, the Standard & Poor’s 500 Index has returned about 2.2 percent.
State and local issuance through May 2 was about $86 billion, the least since 2011. Meanwhile, individuals have added assets to muni mutual funds in 13 of 18 weeks this year, Lipper data show.
The inflows follow an unprecedented withdrawal streak last year amid bets that interest rates would rise. Those expectations remain the consensus.
The median forecast in a Bloomberg survey of 55 analysts is that 10-year Treasury yields will be almost 1 percentage point higher in a year. In 2013, the interest rate jumped about 1.25 percentage points.
“The moment supply picks up,” yields will rise, Rai said. “There’s very little cushion before you’ll get a negative return for the rest of the year. Investors have to be careful -- there is more downside risk than upside.”