Have you noticed the sunshine in the municipal bond market radiating from the Fed’s recent interest-rate cut?
It’s reflected by municipal market analysts, who see the cut as part of a positive environment in which credit fundamentals are strong and muni bonds will be “acting like bonds again.”
The Fed’s long-anticipated move last month, along with three or four additional rate cuts expected next year, typically leads to a steepened yield curve, Nuveen said in a report. A steepened yield curve favors longer-duration bonds, where investors can reap more income.
“With the Fed beginning its cutting cycle, investors can focus on municipal bonds behaving like bonds again: offering tax-exempt income and potential capital appreciation while reducing downside risk,” the company said.
Yield curve steepens
Since July 2022, the yield curve has been inverted, which occurs when shorter-term Treasury yields are higher than long-term yields (“Long-Term Bonds, Not Ladders, Lock in Attractive Yields”). At one point last year, the 10-year to two-year spread was the deepest inversion since 2000.
While the very short end of the yield curve is still inverted, the long end is not. Now, the 10-year Treasury yield is hovering around 4.27% while the two-year yield is about 4.15%.
This is particularly important to municipal bond investors, who focus on the long term.
‘Time to lock in attractive tax-advantaged income’
In addition to a steepened yield curve, municipal bond fundamentals are showing strength, with credit upgrades surpassing downgrades by more than 3 to 1 over the past 12 months. In 2023, the ratio was about 4 to 1.
“Municipal bonds are poised to benefit from the Fed’s rate-cutting cycle, making 4Q 2024 an opportune time to extend duration and lock in attractive tax-advantaged income,” Principal Asset Management said in a recent report.
Historically, tax-free bonds have outperformed three-month Treasury bonds following the start of rate cuts, regardless of whether the economy slips into a recession, the firm noted.
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“For tax-sensitive investors, the value of the municipal tax exemption is currently the highest since 2008,” the firm said.
Year-end move for the future
For muni investors with idle cash, whether it’s from liquidity events or redemptions or just sitting in a money-market account, there are currently exceptional opportunities to secure lucrative yields for the long term.
With encouraging signs and an ample supply of municipal bonds, the sun seems to be shining on muni buyers.