Elections Aren’t the Story for Municipal Bond Investors

Klotz on Bonds

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<h3>James A. Klotz</h3>

James A. Klotz

While the midterm elections may grab headlines, it’ll likely be business as usual for municipal bond investors afterward, regardless of the outcome.

The legislative priorities for the muni market remain as they have for the past few years: Reinstating the tax-exemption for advance refunding bonds and raising the ceiling on bank-qualified debt.

Who wins and who loses in November isn’t likely to affect whether these measures are passed, according to bond market professionals.

“I don’t think this midterm election cycle is quite as potent to the muni market as the 2020 presidential election, or the 2016 election or even 2018,” a municipal bond analyst told The Bond Buyer.

Elections aren't the story for municipal bond investors

Where the focus really is

What is consequential for municipal bond investors are the outsized yields currently available and the strength of issuers.

While much has been made of the net outflows in the municipal bond market so far this year, headlines are now lighting up over “sky-high yields,” as one media outlet exclaimed.

Recently, the 30-year municipal-Treasury ratio was at 102%, above historical norms. The muni tax-equivalent-yield-to-Treasury ratio was a whopping 173% for investors in the 40.8% tax bracket, and this figure doesn’t even account for state income taxes where applicable.

Where in the municipal bond market can investors take advantage of this opportunity?

“Everywhere,” said the head of municipal fixed-income for a major financial institution, at a Bloomberg panel discussion.

Muni yields turnaround

The turnaround in yields began when the Federal Reserve Board started raising interest rates earlier this year to combat inflation.

Inflation fears panicked many investors, who then sold their municipal bond funds, and the market value of all fixed-income investments declined precipitously (“OMG, What Happened to My Municipal Account Values?”).

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    Buyers of individual bonds took comfort in the fact that the credit quality of their bonds didn’t change. These buy-and-hold investors understood this and continued to reap a steady stream of tax-free income while their bonds performed just as they expected. At the same time, they took advantage of the higher yields available on quality bonds.

    Keep in mind, investors who buy individual bonds enjoy a stated maturity date with a promise to pay the full face amount at maturity. There is no such guarantee with bond funds.

    Elections and municipal bond investors

    Although the midterm elections aren’t foremost among our concerns, we nevertheless follow legislative developments as they pertain to the municipal bond market.

    We continue to be confounded, for example, how despite widespread support in Congress and among state and local budget officials, a measure that would reinstate the tax exemption on advance refunding bonds hasn’t become law.

    Further, threats to the tax exemption on interest from municipal bonds are always present, if not conspicuous, and can come from either party.

    The exemption is a “piggy bank that people love to flirt with,” Emily Brock, of the Government Finance Officers Association, told Bloomberg. “The threat is real.”

    For successful individual municipal bond investors, however, elections take a back seat to the more compelling story relevant to their portfolios: Strong issuers and surging yields.


    James A. Klotz is the President of FMSbonds, Inc.
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    Oct 7, 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.