March 6, 2014 / 7:09 PM / 6 years ago

Individuals flee shrinking U.S. municipal bond market

WASHINGTON (Reuters) - Individual investors have been fleeing the U.S. municipal bond market for more than a year, and data released by the Federal Reserve on Thursday shows they now hold the smallest amount of the debt in more than seven years.

Traders work on the floor of the New York Stock Exchange March 4, 2014. REUTERS/Brendan McDermid

The household sector held $1.62 trillion in municipal bonds in the fourth quarter of 2013, compared with $1.647 trillion in the previous quarter. That was the lowest since $1.58 trillion in the first quarter of 2006.

Households are still the biggest investors in a market that has shrunk for three straight quarters. Total outstanding municipal debt ended 2013 at $3.671 trillion, the lowest since it ended 2008 at $3.52 trillion.

Last year proved calamitous for the municipal market.

Spooked by possible interest rate increases and financial earthquakes in Detroit and Puerto Rico, many individuals fled and put their money into the rising stock market. Mutual funds that held Puerto Rico debt because of its special tax treatment were also hit with massive withdrawals.

Meanwhile, issuers ended a refinancing surge amid rising yields, shrinking the supply of new bonds.

The beginning of 2014 has shown the trend could continue. Sales of new bonds hit a 14-year low in February, according to Thomson Reuters data. While money began flowing back into municipal bond funds, Lipper data shows February marked the smallest monthly net inflow, at $422 million, since July 2011.

According to the Federal Reserve, individuals shed $147 billion of municipal bonds in the fourth quarter after dropping $83.1 billion the previous quarter.

The central bank adjusts data on flows of money for seasonal variations in its quarterly “Financial Accounts of the United States” report. The flows, then, may not correspond to the levels of municipal bonds, which are not seasonally adjusted.

Mutual funds also walked away from municipal bonds. They dropped $39.3 billion worth of bonds in the fourth quarter, while closed-end funds shed $100 million and exchange-traded funds $300 million, according to the seasonally adjusted data.

One sign of interest comes from U.S. banks, which held $416.4 billion in bonds at the end of 2013, the largest on record going back to 1951.

Additional reporting by Edward Krudy in New York; Editing by Chizu Nomiyama and Dan Grebler

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