Fixed income

Faced with the loss of stimulus aid, state and local governments are hoping the economy will rebound in time to support their budgets and defuse market concerns over credit downgrades and possible bond defaults, market participants said in their outlooks for 2011.

Record municipal bond mutual fund redemptions have emerged as a threat to the rally most market participants expected to kick off early next year, as the anticipated slowdown in the supply of new bonds is met with a wave of selling by mutual funds.

Investors are also likely to move into corporate bonds and real estate.

The tax-free money market fund industry continues to shrink rapidly, squeezing what had been a major source of short-term credit for municipalities and arguably leading to higher borrowing costs for state and local governments.

Some transaction participants appear to be rushing to market questionable Build America Bond, bank-qualified or other municipal bond deals before tax incentives expire at the end of the year and risking Internal Revenue Service enforcement action for violations of tax requirements, according to market sources.

Investors continued to ferry cash out of their municipal bond mutual funds at historic rates last week as a tumultuous sell-off sowed fear among buyers.

Morningstar said investors pulled $7.6 billion from muni bond funds, the category’s worst month for outflows except for the $8 billion redeemed in October 2008 during the credit crisis peak.

A change in the methodology the Federal Reserve uses to measure who owns municipal bonds has masked the growth in foreign ownership of state and local government debt.

State and local budget challenges will put pressure on municipal credits and will drag overall economic growth next year, according to the Securities Industry and Financial Markets Association’s semiannual economic projections released Monday.

Nearly $500 million added in week ended Dec. 1, partially reversing the $1.85 billion that walked out the door the previous week.

The Securities Industry and Financial Markets Association has upped the ante in its dispute with the Municipal Securities Rulemaking Board over the self-regulator’s proposal to nearly double the fees it collects from dealers, warning that the MSRB must do a better job of explaining the need for the increase.

The municipal bond underwriter and brokerage house hope the tandem will generate broader appeal for investors.

American Funds insists they were years in the making. Others see them as a tactic to stem outflows.

James Hertz, a former vice president and marketer in JPMorgan’s municipal derivatives group, pleaded guilty Tuesday to three criminal counts for engaging in bid-rigging and fraud conspiracies connected with guaranteed investment contracts and other municipal finance agreements, the Justice Department announced.

Issuers in four states have ­accounted for nearly half of the $164 billion of Build America Bonds issued since the ­program’s inception 19 months ago. Municipal market participants say the lopsided ­distribution should be a consideration for investors, but for others the unbalance has limited value in measuring the program’s success.

The ­Securities and Exchange Commission would violate the Tower Amendment and the principles of federalism if it applies its proposed rules on asset-backed securities to municipal bonds, 14 market groups warned this week.

The optimal combination of high corporate bond yields and budding investment returns for defined benefit plans was not evident in this year’s third quarter, as pensions’ worldwide saw an “offset of strong investment returns” due to the decline in yields, Towers Watson said.

The story in the municipal bond market this month has been bleak. The story in the municipal bond exchange-traded fund ­market has been even bleaker.

Many investors think the expiration of the Build America Bond program would actually be good for existing BABs because the entire universe of taxable bond buyers will be fighting over a finite and relatively small pool of available debt.

The SEC should rein in the ABA's CUSIP Service Bureau and prevent it from charging financial market participants unreasonable and unwarranted fees, say three trade groups.