Avoid Distractions as Muni Yields Elevate, Supply Tightens

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<h3>James A. Klotz</h3>

James A. Klotz

Headlines heralding the stampede into money-market funds are obscuring unusual opportunities in the municipal bond market.

For fixed-income investors, it can be a costly distraction.

Tax-free bond yields are scraping years-long highs and most issuers are in relatively good shape – but supply is tightening.

Recently, A-rated, 30-year municipal bonds were available at 4.40% – the taxable-equivalent of 7.43% for investors at a 40.8% tax rate.

Meantime, municipal bond issuance fell 8% last month compared with July 2022. Total issuance for the year through July was $206.77 billion, off 16% from the same period last year.

Avoid distractions as muni yields elevate, supply tightens

Avoid distractions

This news can be overshadowed by the record flow of cash into money-market funds.

But parking cash and focusing on the short term is anathema to successful municipal bond investing.

With muni bonds, investors know the yield they will receive and for how long – either until the bonds are called or mature.

How long will current yields on money-market funds last? No one knows. We are sure, however, that once they decline, the herd will reverse course.

At that point, the prospects of finding attractive long-term municipal bonds at today’s rates will diminish.

‘Adding duration just makes sense’

Further, while it’s anyone’s guess how and when interest rates might change, signs point to the Federal Reserve Board winding down its rate-hike cycle as inflation ebbs and the economy slows.

As we have noted (“Don’t Be Fooled by the Fed”), muni investors look at long-term rates, which ease when there is a slowdown, underscoring the wisdom of adding long-term municipals now.

As one portfolio manager told Barron’s: “We believe we will see yields come down. Adding duration in munis just makes more sense for investors in a high tax bracket.”

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    The cardinal principles for muni investors are to invest when funds are available and look for quality, regardless of market conditions.

    As it happens, the current environment presents an unusual confluence of advantages: Yields we haven’t seen in about a decade, prudent issuers (“States, Locals Showing Prudence Amid Economic Rumblings”) and exceptional value on the long end of the market.

    At the same time, the supply of municipal bonds is shrinking – and we don’t need an oracle to know where that will likely lead.

    It’s simple: Don’t lose sight of an uncommon opportunity to lock in attractive yields for the long term and keep your interest clock ticking.

    James A. Klotz is the President of FMSbonds, Inc.
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    Aug 9, 2023

    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.