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(Reuters) - The withering U.S. municipal bond market will shrink even more well into 2014, with interest rate and credit risks keeping both investors and borrowers away.
Barring an unforeseen turnaround in the final weeks of 2013, municipal bonds will post their first negative annual performance since the financial crisis, with investors fleeing municipal funds at a record pace and the market's overall size, now less than $3.7 trillion, contracting for a third straight year.
Analysts, portfolio managers and traders say concerns about the Federal Reserve scaling back its massive stimulus, and about the financial soundness of state and local governments, will keep hitting the market at least through the first half of next year. They expect debt issuance to fall further and investors to continue exiting bond funds....."In the growth years, 2000 to 2010, you had debt for new infrastructure growing significantly and you had refunding," said Chris Mier, managing director of analytical services at Loop Capital, which forecasts 2014 issuance only at $300 billion. "Now you're seeing ... new money volume for these infrastructure projects flat because of the political environment and the aversion for taking out new debt."
On the demand side, net outflows from muni funds - which have already hit a record $52.76 billion this year - could persist for three to six months, said Vanguard's Alwine.
Outflows during the third quarter alone, $32 billion, exceeded total net outflows of any entire year going back to 1992, according to Lipper, a Thomson Reuters company.
Many funds hold Puerto Rico bonds because they are exempt from state and federal taxes, and some outflows were driven by the territory's budget woes. Detroit's bankruptcy filing - the largest municipal one in U.S. history - also led to outflows.
Still, "maybe 80 percent was driven by fears of interest rates going higher," said BlackRock Managing Director Peter Hayes, who heads the firm's municipal bonds group.
The translation is tax payers will be on the tab for liabilities, while assets will be sold cheap. A ten year jobs/infrastructure plan while the interest rates were very low would have avoided defaulting on debt payments while making a strong revenue stream for cities and states facing financial insolvency.