(Bloomberg) — Municipal bonds are selling off this week, causing state and local government debt to cheapen compared to US Treasuries.
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The rout comes after threats over a pullback in the muni tax-exemption have mounted. Those concerns coupled with recent market volatility, elevated bond issuance and seasonal pressure caused by investors selling to pay tax bills, have put pressure on the public finance market.
“When we talk to customers, the tax-exemption is having an impact — and it’s having an impact even if people are staying on the sidelines,” said Ryan Henry, a strategist at FHN Financial.
Republicans have been searching for ways to raise money to extend 2017 tax cuts and getting rid of the tax break for muni bonds has been floated as one way to help offset the costs. Industry lobbyists have met with members of Congress to make their case for keeping local and state government bonds tax free.
Last week, Stephen Moore, an informal economic adviser to President Donald Trump, said the federal tax subsidy for municipal bonds is at risk of being cut and predicted any change would include a “cap” on the exclusion rather than a broad repeal for debt that is currently outstanding.
“Even if you think there’s a 10% to 20% chance that changes to the exemption touches existing bonds or there’s a cap on exempt interest, shouldn’t that impact prices?,” Henry said. “It should be priced in a little bit.”
Andrew Clinton, chief executive officer of Clinton Investment Management, agrees that “uncertainty and fear” over the tax-exemption may be causing investors to reduce their exposure to munis.
Ten-year, benchmark state and local government bonds are yielding 3.24% on Thursday, about 18 basis more than where they ended last week, according to data compiled by Bloomberg.
Meanwhile, the biggest municipal-bond exchange-traded funds have also seen outflows this week, adding to the drag on the market. BlackRock’s iShares National Muni Bond ETF (MUB) and the Vanguard Tax-Exempt Bond Index ETF (VTEB) have seen three straight days of outflows, according to data compiled by Bloomberg. Additionally, a large high-yield muni bond deal was delayed Wednesday.
The market is also contending with three straight months of increased new issuance compared to bonds taken off the market, according to Henry.