Tuesday, June 09, 2009

Fixed income note 

As someone who frequently accesses the retail market for high quality tax-free municipal bonds (issued in Pennsylvania, in my case), I have noted recently that falling yields in the 2-5 year maturity range reflect significantly increased demand and higher bond prices. On a taxable equivalent basis, the yields for comparable quality and maturity taxable corporate bonds appear to be the way to go at the moment, in some cases by more than 100 basis points (understanding that it is almost never exactly an apples-to-apples comparison). I have started to buy a few corporates to replace maturing munis.

One interpretation of this phenomenon might be that people are bracing for higher tax rates, and those that simply do not want to pay taxes on interest income are bidding up the prices of the higher quality muni issues, thus lowering yields; also, that there may be real concern about medium and lower quality municipal issuers, in terms of falling tax revenues or project revenues that are required to pay down the indebtedness, resulting in a flight to quality. On the corporate bond side, there is still a risk premium baked into the yields of high quality issues of both industrial and financial companies, perhaps a hangover from the events of 2008.

I never buy junk bonds, but there have been some eye-popping yields available on short maturities of companies that are not going to default, and are being priced as if they are.


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