Muni Investors and the Interest-Rate Wait

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<h3>James A. Klotz</h3>

James A. Klotz

When the Fed meets next month, will it deliver to muni investors sitting on the sidelines the long-awaited green light that it’s time to jump back into the market?

After its recent decision to hold rates steady, most analysts predict the Fed will vote to bump rates in December at their final meeting of 2016.

While we don’t quarrel with that view, we advocate a practical analysis of its implications for municipal bond investors.

What municipal bond investors can expect from a rate hike

First, if the Fed does decide to raise rates, it will be miniscule. Remember, the last boost was in December 2015 – the first in nearly 10 years. Surely, anyone expecting a steep sudden rise will be disappointed.

What’s more, the supply of new munis is shrinking. After October’s record-breaking muni issuance of $52.5 billion, the number of issues is tailing off while demand continues to be brisk.

Muni investors and the interest-rate wait

As we pointed out, even foreign investors, unable to capitalize on the tax-free advantage of munis but faced with negative interest rates at home, are turning to the U.S. muni bond market (“Mythologizing Today’s Muni Yields”).

In fact, foreign investors hold $89.7 billion in munis, about three times more than a decade ago, according to Bloomberg.

Finally, consider the conditions behind the years-long struggle to raise rates.

After nudging rates a quarter point in December 2015, most analysts predicted four more rate hikes in 2016, not the single bump now expected next month. While there have been encouraging signs in the economy lately, the case for higher interest rates seems driven more by the bar of low expectations than sustained, robust growth.

Inflation is still below the Fed’s 2.00% target, and despite an economy that is expanding – albeit slowly – for an eighth straight year, infrastructure spending is lackluster. State and local governments, according to the Wall Street Journal, spent an annualized $248.47 billion on construction in August. That’s the lowest amount in almost two years and off about 11% from its recent peak in mid-2015.

Meantime, Europe’s economies are struggling, while the growth of global trade is declining.

A question for muni investors still waiting

For years, potential muni investors have stowed cash in money-losing money-market funds, confident that a spike in long-term interest rates was just around the corner.

The amount of tax-free income they have forfeited is staggering.

If you know people still on the sidelines, you might do them a favor by asking them a simple question: If you were asked a decade ago to predict where interest rates would be today, would you say they’d be higher or lower? If they’re telling the truth, they would say higher, along with virtually every U.S. economist over this time period.

Trying to time the market is futile and costly. Leave Fed watching to the pundits. Regardless of where rates go, you’ll never recoup the income forfeited by being a spectator.

James A. Klotz

President

James A. Klotz is the President of FMSbonds, Inc.
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Nov 7, 2016

Please note that all investing entails risk. Fixed income securities are subject to risks that will affect their value prior to maturity. Some of these risks can be related to changes in market conditions, issuer creditworthiness, and interest rates. This commentary is not a recommendation to buy or sell a specific security. All references to tax-free income refer to U.S. federal income tax. Income earned by certain investors may be subject to the Alternative Minimum Tax (AMT), and or taxation by state and local authorities. Please consult with your tax professional prior to investing. For more information on these topics please click on the “Bond Basics” link below or search by keyword at the top of this page.