The near week-long selloff in short term municipal bonds has been in the works since the beginning of the market's supply drought, market participants agreed.
"We've been a little surprised it hasn't happened sooner," Dan Heckman, a fixed income analyst at US Bank, said in an interview. "The reason is because we've been supply-light across the board. We don't believe you should be purchasing bonds where you're earning a sub-inflation rate type of return.
Heckman said investors could look at six- to nine-year bonds, where duration isn't too far out but still offers stability in the event of rising interest rates. The shorter end of the market has been overvalued and unattractive for buyers, market participants including Barclays Research said.
"In our view, the short part of the market is overvalued, especially the 3- to 5-year part of the curve," Barclays said in a report released on Friday.
Bonds with maturities within four years weakened for a fourth day, finishing about twenty basis points higher in yield for the week.
Federal Reserve Board Chair Janet Yellen said during a question and answer session at a press conference on Wednesday afternoon that the Fed may end its bond purchasing program, known as quantitative easing, in October 2014, and would probably raise interest rates six months after that, in April 2015. Treasuries weakened during Yellen's speech, and munis followed.
The sell-off perplexed some market participants who traditionally invest in short-term bonds in the face of a possible interest rate hike. Traders and analysts said the selloff could be an effect of low issuance this year, which has kept the shorter end of the curve rich.
"We recognize the concerns about duration risk, but think that that the potential for a continued flattening of the Treasury yield curve and muni ratio expansion, as well as lower carry, are risks to the relative performance of shorter-duration munis," Barclays said in the report.
Treasury yields were mixed Friday, as the 30-year yield inched up one basis point to 3.61%. Yields on two- and 10-year Treasuries were unchanged at 2.75% and 0.44%, respectively.
Yields on bonds with maturities from three to six years softened up to seven basis points Friday, adding to Thursday's jump of 11 basis points. Bonds maturing in seven years saw another two-basis point cut in price.
"You haven't seen threes, fives, and sevens move like that in a year," a financial advisor in Chicago said.
Yields on intermediate bonds increased as much as five basis points for those maturing in eight or nine years. The long-end opened steady on Friday.
"It seems like the short end is vulnerable, maybe on the seven more than anything," the advisor said.
The sell-off perplexed some market participants who traditionally invest in short-term bonds in the face of a possible interest rate hike. Traders and analysts said the selloff could be an effect of low issuance this year, which has kept the shorter end of the curve rich.
Municipal funds reported inflows for the sixth consecutive week in the week ended March 20, according to Lipper FMI data. The influx marked the ninth week out of ten that mutual funds have reported inflows.
Some strategists think the trend shows investors will continue to look to municipal bonds during tax season, a typically low-demand time period.
