Municipal-bond week in review: Yields sag then finish strong

Yields on municipal and Treasury bonds sagged this week on concerns about the health of Germany's largest bank, before retracing their steps on Friday.

The 10-year yield on the AP Municipal Bond index was 1.883 percent as of 5 p.m. Eastern time on Friday, after falling as low as 1.840 percent earlier in the week. Yields on 30-year munis, which have stayed in a tight band of 2.421 percent to 2.461 percent since mid-September, were at the high end of that range on Friday. U.S Treasury yields also rebounded from a three-week low earlier in the week.

Most of the action in the U.S. bond market was caused by concerns about the financial health of Germany's Deutsche Bank. U.S. regulators are reportedly trying to extract a potentially crippling settlement payment from the bank over claims about mortgage securities. The worries led investors to buy Treasury bonds early in the week, causing prices to rise and yields, which move inversely to prices, to fall. Municipal bond yields generally follow the pattern of Treasury yields.

Investors in muni bond funds have seen a long bull run, going back more than a year. But the pace has been slowing. Shares of the largest muni bond exchange-traded fund, the iShares National Muni Bond ETF, lost 0.5 percent in September.

In other muni bond news:

— Spreads bounce around

Investors generally demand a premium for holding longer-term bonds, which are more sensitive to shifts in interest rates than short-term bonds. The gap, or spread, between yields of two-year and 10-year municipal bonds narrowed this week to just 0.994 percent on Wednesday, according to the AP Municipal Bond index. That's the narrowest it's been since the first week of July. The spread widened a bit on Friday, ending the week at 1.029 percent.

— Bipartisan boost

A group of Democratic and Republican senators introduced legislation this week that would allow banks to count municipal bond holdings as "high-quality liquid assets." That's an important distinction because large banks will be required to hold a certain ratio of these types of assets, to ensure that they can remain stable in times of financial stress, as part of new financial regulations introduced after the financial crisis. These regulations go into effect in January.

The senators argued that the current rules create a disincentive for banks to hold municipal bonds, which could potentially depress infrastructure funding.