Last week, the Fed’s Open Market Committee said that inflation should remain subdued for the foreseeable future and that it would maintain its current low-interest rate policy for a “considerable period of time.”
Where’s the Inflation?
The Fed’s case was bolstered this week by the Labor Department’s release of the Consumer Price Index (CPI).
The CPI, the most widely followed barometer of inflation, fell 0.2% in November following a flat reading in October. These figures reflect that consumer prices have risen only 1.8% on a year-over-year basis. The “core” index, which excludes the volatile food and energy components, fell 0.1%. This was the first decline in the core rate in 21 years. On an annualized basis, the core rate increased 1.1%, the lowest year-over-year rate in 37 years.
This is continued good news for bond investors. More importantly, it flies in the face of the financial media and pundits who have been beating the drum for higher interest rates for the past few years based on the belief that a robust economic recovery would lead to higher rates of inflation.
Viewed from a historical standpoint, these predictions are not unreasonable considering the recent economic environment. Rates of inflation in the industrialized world are at 40-year lows while most economists expect the growth rate in the U.S. to exceed 4% next year.
However, we have maintained through this period that these economists were underestimating the significant impact of huge productivity gains, intense global competition and excess capacity remaining from overproduction in the late ’90s.
Parking your money is punishing
Municipal bond investors who have “stayed the course” by investing when their funds were available are being rewarded for their discipline. At the same time, those who parked their investment dollars in money market funds and savings accounts, awaiting higher bond yields, have been punished for their attempts to time the market. This is the warning flag we were waving when we began our “Cost of Waiting” series in July 2001.
It is unfortunate that so many potential tax-free bond buyers fell into this trap over the past few years and continue to receive microscopic returns while eschewing the municipal bond market, which is providing historically generous yields, when compared to taxable fixed income investments.
Munis are cheap
Today, muni bond investors are able to buy high quality bonds yielding 5.00% or more. This is comparable to 7.46% on a taxable bond for an investor in the 33% tax bracket. Today, the 30-year Treasury bond, yielding 5.02%, will, after income taxes, net the same investor 3.37%.
Since it is likely that rates will remain low for a considerable period, as stated by the Fed, we can’t understand why some investors continue to remain in money markets yielding less than 1% when they can lock into a steady stream of tax-free income, worth more than 7% a year … after year, after year.
Maybe it’s too simple?