We have a question for those charging headlong into money-market funds and other short-term securities: What’s next?
That is, as the economic environment changes, where will you deploy your reinvestment dollars and reap attractive yields while still getting a good night’s sleep?
To get an idea, let’s examine the source of the yield boon attracting so many investors: The Federal Reserve Board.
When interest rates stop rising
After keeping interest rates near zero for many years, the Fed has gone on a tear, consistently raising the Fed funds rate to slow the economy and rein in inflation.
Last month’s bump – the 11th since March 2022 – pushed the Fed rate from 5.25% to 5.50%, the highest in 22 years.
When might the Fed put the brakes on its hikes?
We don’t know. There is interminable debate over the state of the economy, so what the Fed might do, and when, is akin to reading tea leaves.
What’s not in dispute, though, is that the economy is showing signs of cooling and the Fed’s increases are getting smaller. In June, it left rates unchanged. Otherwise, since February, it has raised rates four times but only a quarter of a percentage point each time.
We also know that when interest rates fall, yields on short-term securities will drop, as will yields on long-term bonds, which are favored by municipal bond investors (“Don’t Be Fooled by the Fed”).
Fed focus obscures opportunity in the muni market
As this scenario unfolds, longtime municipal bond investors understand the big picture. They’re taking advantage of a market offering unusually high yields – the result of other investors who exited the market earlier over inflation fears.
This opportunity, often overshadowed by pundits’ focus on the Fed and the rates of short-term securities, was underscored in a recent Bloomberg article.
The article cites $1 billion worth of New York City bonds issued recently that were priced to yield 4.35%. After taking into account the tax considerations, those in the highest tax brackets earned yields equivalent to an astounding 10% taxable debt.
It’s “pretty significant for a New York taxpayer to avoid both federal and state tax and local tax for that piece of paper,” a portfolio manager told Bloomberg. “That is just tremendously attractive and it was very well received.”
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Of course, it’s not just New York City residents who can reap the benefits of long-term municipal bonds, nor is it limited to those in the highest tax brackets.
Successful municipal bond investing has always been simple: Let munis do their job. Buy and hold quality bonds and keep your interest clock ticking. Trying to time the market for any length of time is futile.
Fixating on short-term yields, which could turnaround quickly, obscures the value of locking in attractive tax-free yields for the long term before they disappear.