Muni Bonds Are Getting Whacked

By on November 16, 2010

Bonds have been weak the last couple of weeks with municipal bonds plunging the most. Some closed-end funds (CEF) such as Invesco Municipal Premium Income Trust (PIA) are down about 15% from their highs in August. PIA, a leveraged fund, was down close to 5% yesterday. PIMCO Municipal Income Fund II (PML), another leveraged CEF, was down nearly 7% yesterday. The iShares S&P National AMT-Free Muni Bd (MUB), an unleveraged ETF, is down about 6% from its peak in late August.

Supposedly, part of this move has to do with a program called Build America Bonds. BABs are an alternative for state and local governments that allow them to sell taxable, as opposed to tax-exempt, bonds and get a cash subsidy from the feds for 35% of their interest costs. The program is due to expire at the end of December. A lot of governments have used BABs instead of tax-exempts, especially at the long end of the yield curve, which has kept new supply, and yields, of tax-exempt bonds at the long end artificially low. The long end of the muni market is now correcting itself based on the assumption that the supply of long-dated tax-exempt bonds will pick up beginning in January.

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