Municipal Bond Forum
What determines muni prices
Q
Assuming interest rates stay steady, do you think muni prices will rise when tax rates rise?
A
James A. Klotz responds:
Assuming no changes in prevailing interest rates, the main determinate of municipal bond prices will be supply and demand.
Current trends overwhelmingly indicate there will be a substantial decrease in the supply of tax-free bonds, while at the same time, demand for tax-free income will be growing.
The issuance of government subsidized Build America Bonds (BABs) is dramatically reducing the volume of new tax-free issues. It is projected that these taxable munis will account for as much as 30% of new municipal financings in the coming year.
As for demand, the Bush tax cuts will phase out in January 2011. The top bracket on ordinary income, including interest income, will rise to 39.6%. High-tax bracket individuals will also be faced with the new 3.8% Medicare tax, which will have them paying a rate on interest income of 43.4% (24% more than the current 35% rate). Dividends, currently taxed at a top rate of 15%, will be taxed as ordinary income, eliminating competition from high-dividend equities.
We see this creating an insatiable demand for tax-free income.
In this environment, we can’t envision municipal bond prices doing anything but moving higher.
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The responses provided in this forum are meant to address specific questions posed by investors about their municipal bonds and to provide market insight for our general audience. Please note, your investments, objectives, results and experience may differ significantly. Our answers and any potential strategies discussed should not be construed as a solicitation to buy nor sell any security or investment product. All investing entails risk.