Prices fell and yields rose in the municipal bond market this week as traders dealt with uncertainty surrounding the government shutdown, looming debt ceiling, and negative headlines out of Puerto Rico.

Video-Muni Week in Review: October 11, 2013

Light issuance in the primary market, coming in at just $3.5 billion, couldn’t whet investor appetite and secondary trading volume slid, both in number and par value of trades.

The number of investor buy trades slipped to 68,897 for the week ending Oct. 9 from 77,315 for the previous week, according to BondDesk Group, which tracks retail trades of under 100 bonds. Investor sell trades slid to 34,141 from 34,218.

Par value of investor buy trades fell to $1.787 billion from $1.966 billion the previous week. Sell trades in par value was nearly even at $937 million from the past week’s $934 million.

Puerto Rico debt drew most of the attention this week after a downgrade to A2 from Aa3 of its senior Sales Tax Financing Corp. bonds by Moody’s Investors Service on Oct. 3.

On Wednesday, Kyle Bass, founder of hedge fund Hayman Capital Management, called Puerto Rico debt “completely junk” on CNBC. The Secretary of Massachusetts William Galvin also announced that day it sent letters to three large mutual fund managers – Fidelity Investments, Oppenheimer Funds and UBS Financial Services – inquiring about exposure to the territory’s credit. The Government Development Bank later announced it will hold an investor call next Tuesday, Oct. 15 to discuss its fiscal situation.

By Thursday, the COFINA bonds were the most actively traded issue out of Puerto Rico, nearing an 8.5% yield. Puerto Rico Aqueduct and Sewer Authority bonds yielded well over 10%, pushing the price down into the range of 60 and 70 cents on the dollar. Government Development Bank bonds fell to 64 cents on the dollar, yielding over 13%.

The market also dealt with continued outflows out of municipal bond funds, which picked up pace to $729 million from the previous week’s $690 million, according to fund that report weekly to Lipper FMI. Funds have reportedoutflows for 20 consecutive weeks.

“Asset classes in general go through these similar cycles,” said Brett Eversole, analyst at Stansberry & Associates. “The most important thing is investors are starved for yield. With zero interest rate policy, after inflation you’re getting nothing. And what’s interesting about munis is they are paying more in yield.”

Eversole said yields are higher than Treasury yields, which historically doesn’t happen because of the tax advantages of munis. On the 30-year, muni spreads to Treasuries are “higher than reason would dictate.”

During the selloff over the past five months, munis sold off as much as Treasuries, and maybe oversold, Eversole said. “Bonds in general are a dirty word to investors today. But the sentiment is too negative and I think that should set up an intermediate term rally in the next six to 12 months. Munis have much more of a value proposition than any other bond today.”

For the week through Thursday, the 10-year Municipal Market Data yield rose six basis points to 2.60% and the 30-year yield increased seven basis points to 4.18%. The two-year yield slid two basis points during the week to 0.35%.

Yields on the 10-year Municipal Market Advisors scale rose four basis points for the week through Thursday to 2.74% and the 30-year yield climbed seven basis points to 4.33%. The two-year yield rose one basis point to 0.55%.

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