Two opposing forces battling each other in the bond market have created a unique opportunity for investors.
On the one hand, the Federal Reserve is trying to fight a slight rise in inflation by raising short-term yields. The market, however, thinks the Fed’s tight monetary policy will push the economy into recession and has driven long rates down. The result is that short- and long-term muni rates are closer than they’ve been in years.
Go long or short?
The problem with short-term bonds – even those with attractive yields – is that they mature before you know it, and you may be left trying to invest your redemption proceeds in a much lower yielding market. If the only alternative were long-term bonds, we’d go long.
But there’s another option in the middle of the curve that represents terrific value.
Currently, bonds maturing in the years 2020 to 2029 have yields that are virtually the same as longer-term bonds yet don’t present the immediate reinvestment risk of short-term securities. Bond traders call this area the “belly” of the curve, and we believe it offers savvy investors tremendous value.
Advantages in the ‘belly’
With 13- to 22-year durations, the belly of the curve offers protection against reinvestment risk and today offers yields of up to 95% of what the investor would receive on bonds that are 30 years or longer. This area of the curve offers investors protection against both scenarios currently playing out in the market.
Should interest rates decline, buyers will have locked in attractive returns for a reasonable period of time. If rates move higher, those invested in the belly of the curve will be able to swap out of their mid-term bonds and take advantage of the new, higher yields on the long end of the market.
Of course, the municipal bond market is dynamic, and while this currently is a rewarding strategy, things change and the window will close.
