Around this time of year, many clients and friends ask us to weigh in on the future of the municipal bond market.
“Will interest rates change? If so, when and by how much?”
“What should we make of the new administration?”
“Should I put my parked cash to work?”
“Will the tax exemption on municipal bonds survive the next Congress?” (“Municipal Bonds Tax Exemption Threatened”).
Trying to accurately predict what’s ahead for any meaningful length of time is a fool’s errand, so we won’t try.
What we can do, however, is offer a look at what actually is occurring, and from that perspective, we are optimistic.
Attractive yields
Today’s yields are the loftiest in years, “providing higher income levels and lowering the correlation between bonds and equities,” Invesco said in a report.
Recently, for example, the tax-equivalent yield on 30-year, A-rated municipal bonds was a whopping 7.09% for investors paying the maximum 40.8% tax rate.
Municipal mutual funds have seen net inflows for 23 consecutive weeks, and more than $42 billion for the year through November.
But there’s more to the market than juicy yields: Credits are strong.
All states boast investment-grade ratings, while 48 of 50 states possess ratings of AA and higher, Invesco said. This year, credit rating upgrades have outnumbered downgrades 2 to 1.
As we have discussed, states have reinforced their rainy-day funds, and many have strong balance sheets (“State of Issuers Aids Robust Muni Market”).
Meantime, U.S. economic indicators look favorable: Economic growth has been steady, unemployment is low and wage growth, while slowing, is proceeding faster than it did in 2020.
As Vanguard’s chief of municipal bonds told Barron’s, “All of those things make for a trifecta for the muni market.”
A mountain of idle cash
It’s hard to imagine, then, that investors have parked a staggering $7 trillion in money-market funds.
Why aren’t they putting that cash to work?
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Certainly, the economic winds could change. Inflation has slowed but hasn’t reached the Federal Reserve Board’s goal of 2.00%. Federal pandemic aid to states is ending, and how the new Congress and administration will proceed is anyone’s guess.
But despite new municipal bond issuance that may exceed $500 billion this year, investor demand is still robust and, if historical trends continue, will accelerate in January as new issuance slows.
For investors with available funds looking to keep their stream of tax-free income flowing, there are numerous opportunities in the municipal market.
And, as we like to remind investors at year-end, there is still time to explore advantageous tax swaps (“Year-End Muni Tax Swap”).
From all of us at FMSbonds, we wish you happy holidays and a healthy and prosperous new year.