With muni yields at historic lows, have you heard anyone say they’ll be moving lower?
Neither have we.
In fact, the decline in yields is what we’ve seen – and predicted – for years, as most advisors were calling for “a rising interest rate environment.”
In the summer of 2011, for example, we suggested that 5.00% yields, offered back then on high quality, long-term munis would soon be viewed with nostalgia by investors (Lincoln was Right). Today, with yields on similar bonds at 3.50%, investors who missed out are downright misty eyed.
Yield curve tells the story
The explanation for where we are – and will likely continue heading – lies in the yield curve. Historically, investors would expect higher yields when buying longer-term bonds. Today, however, the extra yield investors earn on 30-year debt vs. two-year securities is at its slimmest margin since the Great Recession in 2008.
With little difference between long- and short-term yields, the curve is flat, an indication that investors expect minimal inflation and meager long-term growth.
Last year, there was a lot of chatter regarding the prospect of the Fed raising rates for the first time in almost a decade. When the Fed finally decided to act in December, it nudged up rates by the slimmest of margins.
As we pointed out (What Not to Expect from the Fed’s Bump in Rates), it was largely a symbolic though risky move given the precarious state of the economy.
This year, acknowledging the risk of raising rates amid anemic growth, the Fed said it will “proceed cautiously.”
And with good reason.
U.S. growth remains sluggish. Inflation is but a ripple and remains well short of the Fed’s 2.00% target.
Globally, there are few bright spots. Last week, the International Monetary Fund again cut its forecast for global growth, citing weak commodity prices and a continued slowdown in China as key factors.
Don’t be nostalgic later
Many muni investors recognize the situation and are pouring money into long-term bonds.
Unfortunately, too many others still cling to the notion that rates will suddenly turn on a dime, emitting an unmistakable signal that it’s time to jump back in. Until then, they will continue to sacrifice income, parking available cash in money-market funds with negative returns. They will find themselves with no stream of tax-free income and no hope of recouping their foregone returns.
For those who don’t think rates can continue to sink, think again.