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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This report is produced solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. This report is based on information obtained from sources believed to be reliable but no independent verification has been made, nor is its accuracy or completeness guaranteed.