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Battered muni bond market stabilizes, but test looms

October 20, 2009 | 10:22 am

The municipal bond market has stabilized in recent days after a steep, two-week sell-off. A heavy supply of new bonds for sale nationwide this week will show whether tax-free yields have reached levels high enough to lure investors back.

Cash poured into muni bonds in August and September as many investors rushed to lock in yields, fed up with near-zero returns on money market mutual funds and other short-term accounts.

But the strong demand for bonds pushed down interest rates on the securities (as bond prices rise, their yields fall). The annualized tax-free yield on 10-year California state general obligation bonds plunged from 5.25% in late June to less than 4% by early October.

Then the muni market hit a wall, as buyers essentially went on strike. That wreaked havoc with California’s attempt to sell $4.5 billion of new bonds the week of Oct. 5. The state was forced to boost yields sharply to get the deal done.

The sell-off in munis nationwide continued through late last week, pushing bond prices down and yields up. The share price of the Vanguard California Long-Term Tax-Exempt muni bond mutual fund slumped from a 52-week high of $11.39 on Oct. 5 to $11.12 by last Thursday, a loss of 2.4% -- a rude jolt for investors who had forgotten that it was possible to lose money in bonds.

But the fund’s share price has held at $11.12 the last two days, indicating that the selling wave has abated.

"There’s more investor interest with yields up," said Parker Colvin, a muni bond trader at Stone & Youngberg in San Francisco.

The yield on 10-year California general obligation bonds has rebounded to about 4.45%, he said.

But the muni market nationwide will face a glut of new bonds this week, testing whether yields can hold at current levels or whether issuers will have to pay more to attract buyers.

State and local governments including Minnesota, Maryland and Cook County, Ill., will try to sell about $11.3 billion in muni issues this week, the most for any week since June, according to Bloomberg News data. The California Public Works Board will be in the market with an $800-million offering of lease revenue bonds. That sale starts today.

-- Tom Petruno