If the 30-year bull market in bonds is over, someone forgot to tell foreign investors.
They’re piling into munis like never before.
According to Federal Reserve data, foreign investors increased their bond holdings by approximately 5% since last year and, as of the end of June, they owned $77.4 billion in munis, a record.
No tax advantage, no problem
At first glance, it may seem odd, given that investors outside the United States can’t take advantage of the tax-free nature of muni bonds. So what’s the attraction?
Munis are cheap!
That’s right: rates that pundits have decried for years as too low or on the verge of spiking are viewed by foreign investors as a bargain.
From BABs to munis
A few years ago, foreign investors were attracted to the muni market by Build America Bonds, according to a Citigroup report cited by The Bond Buyer. The taxable BABs, part of an effort to stimulate the economy, were issued from 2009-2010.
Today, the yields on munis exceed other U.S. fixed-income securities and dwarf sovereign and quasi-sovereign bonds, which make them appealing to non-taxpayers despite the absence of a tax benefit.
“If you start looking globally where interest rates are, there are a few opportunities out there to buy triple-A bonds at high enough yields,” Mikhail Foux, of Citi, told The Bond Buyer. “That’s the argument that foreigners – given where the European sovereign yields are, when you compare those to U.S. muni yields – they will go after Treasuries as the first stop, and then you can make the argument some U.S. municipalities have better credit than the country.”
The essential advantage
That, of course, is an essential advantage of municipal bonds: Despite a few recent highly publicized problems, investment-grade munis provide an extraordinary level of safety. Historically, the number of defaults is miniscule; issuers are loath to default and can wield numerous tools to avoid it.
That helps explain the widespread and strong demand for munis from foreign and domestic investors. According to Lipper, municipal bond funds reported weekly net outflows just twice since early April.
In recent years, the majority of economists have proclaimed an end to the 30-year “bull market” in bonds. If that’s supposed to portend an easing of demand, it’s obviously wrong as the “bull market” enters its 33rd year.
Regardless, it’s an inaccurate way to view bond investments.
“Bull” and “bear” markets are terms commonly associated with stock watching and market timing, but as we’ve seen, predicting the direction of interest rates is a fool’s errand and the enemy of prudent muni investing. No one has done it with sustained success.
Despite our current, seemingly low-yield environment, the reality is taxes are rising. Effective muni yields are, in many cases, astonishingly high. Factor in the relative safety, coupled with higher nominal interest rates, and munis are a no brainer.