The Strangest Part of the Inflation Report

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<h3>James A. Klotz</h3>

James A. Klotz

We were caught off guard after the hotter-than-expected inflation report last week.

Not that equities fell and there was a selloff in bonds. That was expected, as the report dashed expectations of an imminent cut in interest rates.

What surprised us was the advice to investors afterward, that they, too, should try to predict when inflation might ebb or when the Federal Reserve Board might cut rates.

The notion that after Wall Street missed its prognostication, individual investors should take a swing makes no sense to us.

Strangest part of inflation report

Dubious advice

The Labor Department report in question showed the consumer prices index rose 0.3% in January. Measured over 12 months, the inflation rate would be 3.1%, compared with 3.4% in December.

Forecaster had been eyeing a 0.2% monthly increase, with an annual rate of 2.9%.

The core consumer price index, which excludes food and energy prices, rose 0.4% in January, a bump of 3.9% from last year and unchanged from December; both were above forecasts of 0.3% and 3.7%, respectively.

The report, a strategist told The Bond Buyer, was a reminder that inflation is “sticky.” Over the next few months, he said, investors “are going to have to be walking a tightrope of how much duration they are comfortable with in a potentially rising inflationary environment.” They might want to “keep their powder dry” until they have a better idea of when the Fed will begin lowering rates.

We think this line of thinking runs counter to one of the central fundamentals of tax-free bond investing: Investors don’t have to guess to succeed. In fact, they are more likely to lose out if they do.

Investor don’t guess any better

Let’s be clear: Individual investors aren’t usually any better at predicting the future than professional prophets. By attempting to do so, they’re assuming a responsibility that is futile at best. Worse, they may be forgoing the opportunity to maximize their tax-free income as they wait for their guesses to come true, if they ever do.

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    Investors shouldn’t chase economic headlines. When investable funds are available, look for quality first, then yield.

    As if to underscore the folly of waiting and trying to outguess the market, current municipal bond yields happen to be very attractive.

    “Munis remain rich to taxable bonds, but municipal yields are their highest in a few years,” Nuveen analysts wrote last week. “So we expect munis to remain well bid. We would consider any selloffs as a potential buying opportunity. Demand is high, with too much cash chasing too few bonds.”

    Implicit in the advice of “keeping your powder dry” is the thought that investors will somehow receive a signal that it’s time to jump back into the market.

    But long-term interest rates, which are the focus of municipal bond investors, will most assuredly decline in anticipation of rate cuts by the Fed. They won’t wait for the Fed to act.

    Rather than watching and waiting, we suggest investors carefully consider their options and keep their tax-free income flowing.

    James A. Klotz is the President of FMSbonds, Inc.
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    Feb 22, 2024

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