Bondholders Bail Out Of Municipal Bonds As the Supply Drops

ONLY Ebenezer Scrooge could be happy with the rout the municipal bond market has taken this year.

The number of new issues is down sharply, and refinancing of existing bonds also has fallen to a low level. Bondholders have been bailing out of municipal bonds (``munis'') as quickly as they can speed-dial their brokers. A modern-day Scrooge, with stacks of munis in his portfolio and the financial ability to hold them, might welcome the fewer new issues, saying ``the better to drive up the value of existing older bonds.''

Given the rise in interest rates, however, the outlook for the next few months isn't much better. Bond prices move inversely to interest rates. As rates climb, bond prices drop.

While the bond market, in general, has stabilized recently, ``there's the possibility that we may encounter another selling wave,'' says Arnold Kaufman, editor of ``The Outlook,'' a financial digest published by Standard & Poor's Corporation.

``The sell-off in municipal bonds in October and November of this year was somewhat of a scary drop,'' as investors in bond mutual funds and individual bondholders divested holdings, Mr. Kaufman notes. Within the bond market, all eyes are on the Federal Reserve, which has boosted interest rates to ward off inflation. Inflation erodes the value of existing fixed-income instruments.

In recent years, municipal bonds have become popular because their yields are generally higher than those of United States government bonds and, in some situations, they are exempt from federal, state, or local taxes. Munis are one of the few remaining tax shelters for middle-class Americans.

By the end of 1993, the public held more than $1.1 trillion in outstanding municipal issues. State and local governments sold the bonds to provide financing for taxpayer-supported projects. And the public couldn't seem to find enough bonds to buy.

Last year, a record $289 billion worth of long-term municipal bonds of 13 months or longer maturity were issued or refinanced, says Rich Surich, of Securities Data Company, a financial-reporting firm in Newark, N.J. There were 13,998 new issues.

This year, the number is ``just absolutely down,'' Mr. Surich notes. Through Monday, there were 9,432 new issues and refinancings, valued at $151 billion. That is the lowest volume of new issues since 1990, when bonds with a face value of $126 billion were issued or refinanced.

As for mutual funds investing in municipal bonds, investors have been bailing out in recent months. Thus, the value of assets of long-term national municipal bond funds rose to $141 billion last year; but funds have now fallen to $127 billion in asset value through October 1994, says Malin Jennings, a spokeswoman for the Investment Company Institute, a Washington trade group.

The only area to show stability, she says, is short-term money market funds, where funds with a municipal bond portfolio still attract investor dollars, taking advantage of rising rates.

A number of bond experts believe that investor demand for municipal issues could pick up steam early next year, as interest rates level off. And since it may be that fewer bonds will be issued, bond prices could climb if demand remains steady.

Still, with inflation-forecasting models remaining strong, this is a time for caution regarding the bond market, says James Stack, editor of InvesTech, a market newsletter. While Fed rate increases have an impact on short-term interest rates, market forces drive long-term bond prices, he says. A strong Christmas season retail season could push long-term rates higher and, thus, drive down bond prices, Stack explains.

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