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Muni Bond ETFs Out of Favor: Any Upside Ahead?

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Municipal bonds have been under pressure lately as yields on U.S. benchmark treasuries are up about 70 bps this year. Though trade tensions keep a check on the fast rise of treasury yields in the July-August period, yields started trending higher starting mid-September.

While the 10-year treasury yield is hovering around a seven-year high, the yield on the benchmark two-year note hit as high as 2.906% on Wednesday, marking its highest level since Jun 25, 2008.

Investors have yanked assets from muni ETFs as evident from $203.9 million of outflows from iShares National Muni Bond ETF (MUB - Free Report) . Vanguard Tax-Exempt Bond ETF (VTEB - Free Report)  “got hit with a massive outflow of over $25 million on Monday, the biggest since the $3.6 billion fund launched in 2015," according to Bloomberg, as quoted on Investopedia.

Traders have increased their short positions in State Street Corp.’s $2.8 billion SPDR Nuveen Bloomberg Barclays Municipal Bond ETF to the highest on record, per Bloomberg. And short interest in BlackRock Inc.’s $9.4 billion MUB has leaped to the highest level since late 2017. After all, these tax-exempt debts are not that appealing these days thanks to President Trump’s tax cut measures.

The S&P Municipal Bond Index dropped 0.58% in September as seasonal market trends turned less satisfactory, sending the fund into negative territory (-0.16%) from the year-to-date frame. Strong economic data, a hawkish Fed and a diminished tax benefit for pension buyers gave yields a boost and weighed on muni bond ETFs, per BlackRock.

What to Expect in the Near-Term?

Per BlackRock, investors should keep an eye on the near-term movement in the muni market. BlackRock expects the likelihood for market technical to act as a near-term drag as supply takes a leap during the fall months.

Is Long-Term Outlook Bright?

The note issued by BlackRock noted that the creditworthiness of munis have improved a lot. “According to Bloomberg News, this is the first time since 2008 that none of the 50 states have carried a negative outlook on their S&P ratings.”

Moody’s reported that 23 state governments have enough reserves to survive a budget shortfall if the U.S. economy suddenly falls in a recession, up from 16 last year, while “another 10 states have most of the required reserves.”

Several other analysts like Morgan Stanley see demand for munis to pick up in the ongoing fourth quarter. The mid-term election in November may cause volatility in the market and keep a check on the rise of the bond yields and boost muni bond prices.

Munis are comparatively more stable than equity or high yield bonds, making them great picks in any economic turbulence.Plus, high-yield muni bonds can win over high-yield corporate bonds for investors, who are in search of higher current income.

Muni Bond ETFs in Focus

While the space has been subdued of late, below we highlight a few muni bond ETFs that remained in the green or lost the least in the past four weeks (as of Oct 10, 2018) (see all municipal bond ETFs here).

Pimco Short Term Municipal Bond Fund (SMMU - Free Report) ) – Up 0.1%

Invesco VRDO Tax-Free Weekly ETF (PVI - Free Report) ) – Up 0.07%

iShares Short Maturity Municipal Bond ETF (MEAR - Free Report) ) – Up 0.07%

VanEck Vectors Pre-Refunded Municipal Index ETF (PRB - Free Report) ) – Up 0.03%

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