Replenishing After Muni Redemptions

Klotz on Bonds

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<h3>James A. Klotz</h3>

James A. Klotz

It’s that time of year again, the season when a stream of principal and interest is returned to municipal bond investors and issuance slows to a trickle.

A surge of redemptions, calls and interest payments isn’t unusual during late spring and summer, nor is the potential imbalance between supply and demand (“Summer Forecast: A Muni Redemption Flood, Supply Drought”)

But it does present a question as to where investors might deploy their incoming cash.

Replenishing after muni redemptions

Summertime supply lag

From May through August, analysts estimate $231 billion of municipal bonds will mature and be called, and interest payments will be made. New issuance, on the other hand, is expected to be about $160 billion during the same period.

In May alone, the supply deficit – cash available for reinvestment vs. new issuance – could reach about $16 billion, according to Raymond James. In June, it’s estimated to be $6 billion.

If new issue supply continues at a pace similar to the start of the year, supply from June through August will be about $135 billion, less than the $153 billion of principal and interested expected to be returned to investors in that time, Raymond James reported.

Attractive taxable-equivalent yields

For almost two years, money-market funds have been a siren song for many investors choosing to park their cash. Elevated yields have attracted more than $1.2 billion into these funds since October 2022.

We wonder, however, whether investors sidelining their cash have considered what happens when yields on money-market funds ease, as they invariably will.

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    Of course, we don’t know when that will happen, but we’re certain there won’t be a clear, discernible signal to investors that’s it’s precisely the right time shift their cash.

    What’s clear, though, is that tax-free bond yields are at years-long highs. Consider, for example, that the taxable equivalent yield on 30-year, A-rated municipal bonds for investors paying a 40.8% tax rate was recently a whopping 7.23%.

    Plan now

    With a supply/demand imbalance, we expect municipal yields to ease and municipal-to-Treasury yield ratios and spreads to narrow.

    For investors with cash to invest, preparing for what’s next will help ensure an uninterrupted flow of tax-free income.

    We know a mass of redemptions and interest payments is on the horizon. Fortunately, for those who plan, now is a particularly advantageous time to put their cash to work.

    James A. Klotz is the President of FMSbonds, Inc.
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    May 16, 2024

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