This June and coming July will represent the peak in municipal bond maturities for the year, with an estimated $87 billion dollars coming due. If you find yourself owning one of these bonds, then I would encourage you to proceed with extreme caution. There are two reasons for this and they are as follows:
1) New-issuance was down 32% last year and that trend is expected to continue.
2) Interest rates remain at historical lows.
With new issuance continuing to look sluggish, municipal bond investors will be competing against each other for the few new-issues available. With pickings slim that may lead investors to base their decisions purely based on yield. That leads me to my second concern and that is the fact that interest rates remain at or near all-time lows.
With interest rates at zero it does not take much insight to realize that at some point, rising interest rates will send long-term bond prices down. It is just a matter of "when" rather than "if". This rise in interest rates could come from an explosion in inflation, which is not good for anyone, or from strong economic growth over the next few years. The fact that long-term bond prices have been sent artificially higher by the Fed's "Operation Twist" program scares me. For those of you that are not familiar with "Operation Twist", it is a program that was implemented because the Fed can't reduce short-term interest rates any further because they're already at zero. Therefore, the Fed wanted to reduce long-term interest rates instead. They do this by selling short-term bonds and using the proceeds to buy long-term bonds. When you buy more of something, you raise the price. When you raise the price of a bond, you lower the interest rate. So what the Fed is doing is artificially lowering long-term interest rates.
Investors who are in absolute need of federally exempt income and cannot resist the temptation to buy another issue with the proceeds, may want to consider a shorter duration municipal bond ETF. With few issues to pick from and interest rate risk looking down at us, I feel shorter duration options would be the prudent way to go at this time. Here are few national municipal ETFs that are composed of shorter to intermediate term bonds:
Market Vectors Intermediate Muni ETF (ITM) - Average duration is 8.49 years ; 12-mo yield = 3.02%
Columbia Intermediate Muni Bond Strategy Fund (GMMB) - Average Duration is 5.59 years ; 12-mo yield = 2.52%
SPDR Nuveen Barclays Capital Short-Term Muni Bond (SHM) - Average Duration is 2.84 years; 12-mo yield = 1.38%
PIMCO Short Term Muni Bond Strategy ETF (SMMU) - Average Duration is 1.79 years; 12-mo yield = .97%
As is the case with most national municipal portfolios, you may not receive exemption from state and local taxes, but at this time that sacrifice may be worth it to protect your principal over the long-term.