Returns in the $3.7 trillion municipal bond market are set to “cool off” in the next three months amid rising interest rates, according to a report from Morgan Stanley analysts led by Michael Zezas.
State and local bonds have earned about 3.4 percent this year, after a 2.9 percent decline in 2013, according to Bank of America Merrill Lynch data. The 2013 loss was the first for the $3.7 trillion market since 2008.
Ten-year Treasury yields, at about 2.7 percent today, should reach 3.3 percent in the fourth quarter as the economy strengthens, according to the report from the New York-based bank. Zezas’s most likely scenario is that munis post an annualized negative loss of 1 percent over the next three quarters.
“As the economy transitions to a higher growth channel, we expect some more pain from rising rates before valuations become attractive,” Zezas wrote.
If state and local bonds decline this year, it would be the first back-to-back annual losses in more than three decades.
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