CHICAGO Dec 27 Investors pulled another $2
billion from U.S. municipal bond funds in the latest week,
underscoring fears that potential sweeping tax changes under
President-elect Donald Trump and a Republican Congress will
undermine the tax-exempt debt market.
Trump's plans to cut taxes and increase fiscal spending have
already boosted inflation expectations. As a result fixed-income
markets, already weighed down by forecasts for tighter U.S.
monetary policy, have see prices slump while stocks have reached
Since the Nov. 8 election, munis suffered more than any
other fixed-income sector with a negative total return of 3.229
percent, according to Bank of America Merrill Lynch indices.
Trump wants to reduce the current seven tax brackets to
three: 12 percent, 25 percent and 33 percent. This mirrors a
June tax proposal by U.S. House Republicans but the House
proposal would also allow taxpayers to deduct 50 percent of
their capital gains, dividends and interest income, shrinking
overall taxes even further.
"It just seems that municipals would have to readjust in
terms of yield, a little bit higher yield, to bring itself back
into parity proportionately with other asset classes to remain
competitive," said Jim Colby, chief municipal strategist at
Tax-exempt bonds, which outperformed other fixed-income
assets in 2015, are on track to have the only negative return,
albeit a small one, for all of 2016.
As of last Wednesday, munis returned a negative 0.078
percent versus positive returns of 0.551 percent for Treasuries
and 5.158 percent for corporate bonds, BAML reported.
The corporate tax rate, as envisioned by Trump, would fall
to 15 percent from 35 percent, making muni bonds less attractive
for tax-exempt debt buyers like banks and property and casualty
Wealthy investors subject to federal income tax rates
currently as high as 39.6 percent are traditional buyers of
tax-free bonds sold by states, cities, schools, nonprofits and
Investors are fleeing from muni bond funds. The net outflows
have grown for six straight weeks to $13.5 billion since the
U.S. election, according to Thomson Reuters Lipper service. The
muni market is $3.7 trillion overall and until recently was the
beneficiary of 54 straight weeks of fund net inflows.
DO TAX RATES MATTER TO MUNIS?
While there is talk of a tax reform bill moving through the
House relatively quickly, past history indicates a vote by the
August recess, setting up a Senate vote in the fall and
potential signing by Trump before year-end. If progress stalls,
tax reform could lay dormant during 2018's election year.
Some question the tax impact on the municipal bond market
Philip Fischer, municipal research strategist at BAML, said
tax rates are no longer the driving force behind muni purchases
and that tax-sheltered investment vehicles have replaced
competition from other fixed-income assets.
"What is going on is that munis have to yield enough so they
are competitive with other tax sheltered instruments like
401k's," he said.
The tax-exempt market should have some time to adjust before
the first major U.S. tax changes materialize since 1986's
massive reform law.
"We really believe if it really does happen it's more of a
2018 event not a 2017," said Dan Heckman, national investment
consultant at US Bank.
Meanwhile, muni issuers are facing higher borrowing costs
than just six months ago.
A rise in yields on Municipal Market Data's benchmark
triple-A scale from record lows reached this summer accelerated
after the election.
The yield on top-rated 30-year bonds ended Friday at 3.11
percent, which is 118 basis points up from its 1.93 percent low.
For 10-year bonds, Friday's 2.39 percent yield was 110 basis
points over the all-time low of 1.29 percent.
Issuers took advantage of historic low rates to refund old
debt and sell new bonds, pushing 2016 issuance to $423.5 billion
as of Friday, just short of 2010's record $430.35 billion
supply, according to Thomson Reuters data.
"We could envision a market totaling $350 billion (in 2017),
about $100 billion less than this year, but this of course
depends heavily on how the proposals play out," Natalie Cohen, a
senior analyst at Wells Fargo, said in a December report on
potential tax changes.
Refundings of existing bonds, which accounted for about 61
percent of 2016 issuance, would not screech to a halt given the
impending 10-year call on hefty amounts of debt issued in 2007,
(Reporting By Karen Pierog, additional reporting by David
Morgan in Washington; Editing by Daniel Bases)