Municipal-bond week in review: Yields back down a bit

Markets Associated Press

After a month of steady increases, municipal bond yields finally reversed course this past week.

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The 10-year yield on the AP Municipal Bond index was 2.665 percent, as of 5 p.m. Eastern time Friday. That's down from 2.808 percent the previous week, but it's still a lot higher than a month ago, before the election, when the yield was just 2.063 percent.

Yields on two- and 30-muni year bonds also fell. On Friday, the long-term 30-year bond yielded 3.403 percent. A week ago, it was 3.565 percent.

Bond yields and prices move in opposite directions, and prices may have climbed this past week as investors questioned whether the earlier losses were overdone. "People think that munis had sold off a little too much, and now there are buyers coming back into the space," says Jon Mondillo, a municipal bond fund manager at Alpine Funds.

The fall in yields propelled the iShares National Muni Bond ETF, the largest municipal bond exchange-traded fund, to a one-week return of 1.1 percent.

The gap, or spread, between yields of two-year and 10-year municipal bonds narrowed this week to 1.34 percent, according to the AP Municipal Bond index. Long-term bonds are considered riskier, and offer higher yields, than short-term bonds. The gap was narrower Friday than it has been in a few weeks.

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CREDIT RATING OUTLOOK

Credit quality for U.S. public finance should remain fairly stable for next year, but states will likely see more downgrades than upgrades, according to a new report from S&P Global Credit.

S&P lowered state credit ratings nine times this year through December, including two downgrades for Illinois. That's a record for a single year. S&P currently has a negative outlook on 10 states, largely related to budget pressures from weak oil prices and underfunded pensions.

Expectations are better for local governments, which are benefiting from a stronger economy. Health care and housing, on the other hand, may weaken depending on the outcome of federal legislation.

"Public finance has had several years of an upgrade trend, but that trend is starting to slow down to some degree," says Larry Witte, a senior director at S&P Global and one of the authors of the report.

While municipal bond defaults are very rare, this year has seen 14 as of November, an unusually large number. Most of these were related to the Puerto Rico budget crisis. S&P expects to see a similar number of defaults in 2017, and for them to again be mostly concentrated in Puerto Rico.