Are municipal bonds coming back into favor? Some industry analysts seem to think so.

As recently as January and February, investors were reading headlines like Business Insider’s “Municipal Bonds in Trouble,” and the Wall Street Journal’s only slightly less worrying “In Muni-Bond Ills, Danger and Hope.”

For two years, money was fleeing munis as cities and counties around the country-- particularly in high-growth states like Florida, California and parts of the Southwest -- fell on hard times and property tax revenue dried up.

Now funds are flowing back into less risky, lower yield munis and muni funds,  according to Jim Colby, senior municipal strategist at Van Eck Global, which oversees Market Vectors ETFs which includes some muni-bond exchange traded funds. There have even been some significant inflows into the high-yield sector of the market of late.

Part of this improved investor perspective on muni bonds has to do with an improved outlook for the issuers -- a sense that municipalities have been getting their financial houses in order and that the risk of default is way down from where it was a year or two ago. 

As Jay Powell, former U.S. Treasury Department official and a visiting scholar at Bipartisan Policy Center, a Washington think tank, puts it, “Yes this is the worst stress the system has been under for many, many years, but predictions of widespread defaults are overblown.”

Part of it could also be a search by investors leaving equities for higher-yield options for their money, given the general low-interest rate environment still being promoted by the Federal Reserve. 

As Kim Rupert, a fixed-income analyst at Action Economics, explains, with Treasury yields so low, “people are looking for a little something extra.”

As of June 9, a 10-year Treasury was yielding 3.125%. That compares to a typical 10-year muni yield of 2.569%, but of course, the muni bond is tax exempt, making it equivalent to a taxable yield of 3.568%.

Municipal issuers are expected to sell $7.33 billion in muni bonds this week according to the research firm Ipreo, which would mark the highest one-week issuance this year.

That said, muni issuance is still less than half what it was at this time last year.  Experts are predicting total muni bond issuance in 2011 to check in between $225 billion and $250 billion, well below 2010’s total of $431 billion.

With 70% of municipal bonds held by individuals, investor sentiment plays a big role in price movements in this market. 

It was warnings last December by prominent financial analyst and bond expert Meredith Whitney of “hundreds of billions of dollars” in muni bond defaults that spooked the market in early 2011  And Whitney hasn’t backed off, claiming that the credit conditions in the muni market “have only gotten worse.”

So far, investors don’t seem to be as worried this time.


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