Notes on the Current State of the Muni Bond Market
by Annette Thau
Are you worried about your bonds (or your bond funds)?
The fixed-income markets are currently getting very bad press. No less an oracle than Warren Buffett recently dubbed bonds “instruments of mass destruction.” The perception that risk is high is primarily due to the fact that interest rates remain at historic lows. The consensus seems to be that interest rates can only go up and this creates interest rate risk: When interest rates rise, the price of a bond (or a bond fund) declines. The extent of the decline is directly related to maturity length. The other face of interest rate risk, of course, is that when interest rates decline, the price of bonds rises. Again, the extent of the increase is tied directly to maturity length.
Interest rate risk affects all fixed-income securities, including Treasuries. Discussions of interest rates and interest rate risk all start with Treasury bonds. More precisely, these discussions focus on the bellwether 10-year Treasury bond, since interest rates in other sectors of the bond market typically follow Treasury rates, either up or down. If interest rates rise on Treasuries, so will those of municipal and corporate bonds.
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