February 27, 2012

Municipal Bond Yields Low, Rising

S&P index bond yields exceed Treasury bond yields

Tax-exempt investment-grade municipal bonds as measured by the S&P National AMT-Free Municipal Bond Index have returned 2.41% so far this year, according to S&P Indices’ Vice President of Fixed Income Indices J.R. Rieger. In a research note released Friday, Rieger said that demand for these bonds continues to outstrip supply with municipal bond mutual funds continuing to see cash inflows.

The S&P Municipal High Yield Bond Index returned 4.11% and yielded over 6.9%, with a taxable equivalent yield of over 10.5%. A key driver of this growth in the high-yield market is the health care sector returning over 3.6%, according to Rieger.

For bonds maturing in 2021, those included in the S&P AMT-Free Municipal Series 2021 Index, yield is up 33% over the 10-year Treasury bond at 2.65%. Using a 35% tax rate, according to Rieger, results in a taxable equivalent yield of 4.08% or over double the yield of the 10-year Treasury bond.

Long-dated municipal bonds as measured by the S&P Municipal Bond 20+ Year Index have returned 3.8% year-to-date with a 4.98% yield. By comparison, long-dated Treasury bonds have lost 3.17% and are yielding just over 3%.

“The yield curve had been flattening earlier in the year but has begun to steepen in the last three weeks. A steepening curve means longer maturity bond prices will take the brunt of any yield increases,” Reiger said. He referred to the S&P AMT-Free Municipal Series 2013 and 2021 indexes, which fell slightly from 225 bps at year end to 222 bps as of Feb. 23. “These indices track actual non-callable municipal bonds that mature in June, July and August of the years measured, so they give a true reflection of steepness of the curve.”

The yield spread between high-yield municipal bonds and investment-grade municipal bonds has narrowed by 49 bps since year end to 371 bps, Rieger said. “The spread narrowing indicates the market is willing to take on more risk for higher yield.”

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