Municipal Bond Forum
More on “A Forward Strategy for the Inverted Yield Curve”
Q
As a client of yours, and a reader of your bond forums, which I really enjoy, I had some thoughts on your article. What you wrote makes sense, but what would be the problem with buying a 10-month or one-year CD, which is paying close to a 5% yield, and after the maturity of the CD, investigate yields of long-term munis. Can long-term muni bonds go any lower? I don’t think so. At some point the yields would have to rise. Does this make sense?
A
James A. Klotz responds:
The point I attempted to make in my commentary was that by the time your CD comes due, there is a good chance that long-term yields would be significantly lower than they are today.
Since 1978, the curve has inverted eight times, with the average duration only 7.5 months. History reveals that yield curves didn’t stop inverting because long-term rates rose, but because short-term interest rates fell much faster than long-term rates. Ten-year Treasury bond yields fell .66 basis points (percentage points), on average, in the six months following an inversion cycle, while the yield on two-year Treasuries declined almost twice as much (1.21 basis points).
Today you can buy high quality tax-free bonds with a 15-year maturity to yield approximately 4.50%. This is equivalent to taxable bond yields of 6.25% and 6.92% for investors in the 28% and 35% tax brackets, respectively.
Remember, the after-tax yield on that 5.00% CD is only 3.6% in the 28% tax bracket and only 3.25% in the 35% bracket.
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