‘OMG, What Happened to My Municipal Account Values?’

Klotz on Bonds

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<h3>James A. Klotz</h3>

James A. Klotz

Many investors opening their March statements were undoubtedly surprised by their municipal account values.

As interest rates skyrocketed, market values of all fixed-income investments declined precipitously in the first quarter of 2022.

The Federal Reserve raised short-term interest rates by 25 basis points in March and promised to relentlessly continue these hikes for months to come.

The debate surrounding the Fed and its ability to stay “ahead of the curve” was finally clarified. The Fed was clearly slow to act in the face of accelerating inflation.

Municipal account values

No interest-rate markets were spared

The two-year Treasury note yield climbed by 120 basis points, to 2.32%. These notes were paying 1.73% at the end of 2021.

The 30-year mortgage rate rose from 3.32% to 4.37%.

More important to our clients, the municipal bond market performance was also cheerless.

The Bloomberg Municipal Bond Index was down 6.20% for the quarter. High-yield bonds followed suit, declining 8.10% for the quarter.

On a positive note, holders of individual bonds have a much better outlook than investors in muni mutual funds and ETFs.

The managed mutual funds and ETFs will face a much greater challenge to return to their 2021 prices than will their individual bond counterparts.

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    Investors in individual bonds have a stated maturity date and fixed-income payments that cannot be altered.

    Mutual Funds and ETFs have no maturity date as they contain a variety of bonds with various maturity dates. This means there is no promise to return their original principal and dividend payments are not fixed.

    The decline in the Net Asset Values of these funds can be quite unsettling, considering the holders are also assessed management fees.

    Beyond temporary municipal account values

    Although individual municipal bond holders have also seen their market values decline, they recognize that sometimes their bonds will be worth more than they paid for them – which has been the case in recent years – and sometimes less.

    The reason for the brighter outlook is they know there is a promise to pay principal on a stated date and throw off a steady, dependable stream of tax-free income in the meantime.

    They are also happy to take advantage of opportunities in the municipal bond market, with yields higher than we’ve seen in almost a decade.

    After the rate hikes

    Our expectation is that these higher rates will not prevail for an extended period of time.

    In the past, when the Fed has played “catch up” and raised rates aggressively, an imminent recession or at least an economic slowdown has usually followed.

    This, invariably, leads to a decline in long-term interest rates.

    We don’t pretend to know the future. But we are confident that investors’ statement shock over their municipal account values in March is temporary.

    For those investing in individual issues, it’s immaterial and, in fact, presents a unique investing opportunity.

    James A. Klotz

    President

    James A. Klotz is the President of FMSbonds, Inc.
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    Apr 12, 2022

    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.