Muni bond yields jump again after New Jersey governor uses the B-word

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If nervous investors were looking for another excuse to stay out of the battered municipal bond market, they got it from New Jersey Gov. Chris Christie on Thursday.

Speaking at a town hall meeting, the Republican governor warned that healthcare expenses for public workers “will bankrupt� the state if those costs aren’t reined in.

Christie may not have meant it to be taken literally, but a governor probably shouldn’t be dropping the B-word in a muni market that is already so badly spooked by fears over state and local government budget woes.

Prices of muni bonds fell broadly for a fourth straight session Thursday, driving yields on some securities to new two-year highs.

The annualized tax-free yield on a Bond Buyer index of 40 long-term muni bonds nationwide (charted at left) jumped to 5.86%, up from 5.77% on Wednesday and the highest since January 2009.

Historically, spikes in muni bond rates have attracted yield-hungry individual investors, long the backbone of the muni market. Yet those investors remain “very cautious� about stepping in now, said Kevin Giddis, fixed-income head at brokerage Morgan Keegan Inc. in Memphis, Tenn.

The latest sell-off marks a new phase in a muni slump that began in November. In the first phase the market was slammed by a rise in interest rates on longer-term bonds in general and by a rush of new bond issuance by many states and municipalities.

More recently investors have been put off by worries over worsening state and local government budget troubles and the risk that some borrowers could renege on their debts. And in particular the market has been terrorized by Wall Street banking analyst Meredith Whitney, who again this week predicted a surge in muni bond defaults.

Christie just tossed a few more logs on the market fire that Whitney has been fanning. And mutual fund giant Vanguard Group didn’t help sentiment after it postponed plans to launch three exchange-traded funds that would have tracked muni market indexes. Vanguard cited “market volatility.�

Still, at some point tax-free muni yields should reach levels that many investors just can’t pass up.

Are we there yet? George Strickland, who helps manage $6 billion in muni bond mutual funds at Thornburg Investment Management in Santa Fe, N.M., said the yield on 30-year California general obligation bonds was just above 6% in trading late Thursday.

For a California couple in the combined 32.2% federal and state marginal tax bracket (joint taxable income of between $92,699 and $137,300), a 6% tax-free yield is the equivalent of earning a fully taxable yield of 8.84%.

By contrast, the U.S. Treasury sold new 30-year bonds on Thursday at a yield of 4.52%. And that interest is federally taxable.

Tom Spalding, a muni fund manager at Nuveen Investments in Chicago, said he expected to see more institutional investors that typically buy taxable bonds instead shift soon to the muni market to take advantage of current tax-free yields.

“Then all of a sudden people will say, ‘Hey, I missed something,’ and they’ll come in too,� he said.

But as the chart above shows, buyers who jumped into the market in mid-November and in mid-December were too early if they thought they were buying the peak.

Is the third time the charm?

-- Tom Petruno

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