Muni Investors’ Guide to Recent Economic Data

Remember the veritable firehose of conjecture on when the Federal Reserve Board would begin trimming interest rates?

Inflation was easing, yet the economy was humming. Perhaps, many clamored, the economy might achieve a “soft landing” after all.

More recently, however, the talk has turned to fewer rate cuts this year than previously anticipated – and even the possibility of rate hikes.

And then the latest growth and inflation numbers came out.

Economy is slowing, inflation still stubborn

For the first quarter, economists predicted an annualized GDP rate of 2.5%, while the actual rate was 1.60%, according to Bloomberg. Personal consumption, estimated at 3.00%, came in at 2.50%.

Meantime, the GDP price index was reported at 3.10%, up slightly from estimates of 3.00%, and the core PCE Price index – the prices we pay for goods and services, a significant driver of GDP and a window into underlying inflation – was 3.70% vs. economists’ estimates of 3.40%.

The economy is slowing, the figures are telling us, but inflation remains above the Federal Reserve Board’s targets. The chances of imminent rates cuts look more remote while the Fed keeps rates higher for longer than it anticipated.

At its latest meeting yesterday, the Fed again held the line on rates, with the chairman saying inflation is still “too high.”

In parsing Fed’s statements, it’s important for tax-free bond investors to keep this in mind: The longer rates stay higher on the short end, the more precipitous the decline will likely be on the long end once the Fed does decide to cut rates.

The Fed only sets the federal funds rate, the interest rate banks charge each other to lend overnight, the shortest of interest rates. Muni investors, on the other hand, focus on long-term rates, which are determined primarily by the buying and selling of municipal bonds. Long- and short-term rates, in other words, don’t move in lockstep (“Don’t Be Fooled by the Fed”).

How today’s yields will be seen in the rearview

Data from one quarter doesn’t indicate a trend. As the economy slows, the Fed will be mindful of higher rates that might set the stage for a recession. Indeed, the central bank faces a formidable balancing act.

Reading the Fed’s tea leaves and attempting to stay ahead of economic data that no one can accurately predict in the long run is a fraught exercise. Daily news is enlightening but ultimately fruitless as a personal finance tool.

We are confident, however, that the muni yields we’re seeing today look awfully attractive and will look even more appealing when rates finally ease.

Remember, over the past decade, yields were 2.00% to 3.00%. The recent tax-equivalent yield for high-quality tax-free bonds, on the other hand, was a whopping 7.20% for those paying a tax rate of 40.8%.

Amid a slew of economic data and even more conjecture, municipal bonds are doing precisely what we want them to do: Provide a good night’s sleep – with the added bonus of outsized yields.