The $3.7 trillion municipal market will decline in 2014 after falling in value this year, the first two-year losing streak in more than three decades, according to Barclays Plc.
Fixed-income yields will continue to rise as the Federal Reserve scales back its bond buying, extending a slump in state and local debt, said Tom Weyl, director of municipal research at Barclays in New York. Munis have declined 2.6 percent this year, according to the London-based company’s index data. The bonds will lose 1.45 percent in 2014, Weyl said.
Weyl joins Michael Zezas at Morgan Stanley in forecasting back-to-back years of negative returns for munis. The last time that happened was 1980-1981, according to Barclays data.
“When the Fed starts tapering, we’re still going to have some negative reaction in the marketplace,” Weyl said in a telephone interview. “After some time period, the value of munis will become apparent.”
Individuals have pulled $52 billion from muni mutual funds this year, the most in at least two decades, on speculation that the Fed’s policy will push interest rates higher and that Detroit’s bankruptcy and Puerto Rico’s shrinking economy signal more local-government distress.
State and local bond losses will still be smaller than those on Treasurys in 2014 as higher interest rates boost the value of munis’ tax exemption, Weyl said.
“We’re not necessarily forecasting an absolute turn in the fund flow dynamic, but we’re looking at the muni exemption becoming more valuable,” Weyl said. “Munis typically tighten to Treasurys in a rising rate environment.”
Investors should buy bonds with longer maturities because their interest rates won’t increase as sharply as those due in five to 10 years, Weyl said. Debt from hospitals, water and sewer systems and industrial-development projects may provide better returns than other issuers because their yield spreads are wider than the historical average, he said.
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