Trending
With the Federal Reserve nearing its first interest rate cut since the dark days of the coronavirus pandemic, it’s predictable that a variety of fixed income assets are garnering renewed attention from advisors and investors. That includes municipal bonds.
There’s no doubt rate cuts have been widely telegraphed and that’s reflected in the recent performance of municipal debt. For the three months ending Sept. 16, the ICE AMT-Free US National Municipal Index is higher by 2.2%, which is an impressive showing over such a short amount of time. It’s possible performance implies muni upside is limited over the near-term. That could prove accurate, but it could also prove false.
Point is bonds of many stripes, including munis, should bet some boost when rate cuts become official. Specific to munis, that’s a positive for various reasons, including the point that this corner of the bond market has long been a favorite of advisors and clients alike. As advisors know, some municipal bonds offer tax benefits, nearly all are at the lower end of the risk spectrum and the income they provide is steady, which is to the benefit of clients, including retirees.
Then there’s history. Longer-dated munis typically benefit from Fed easing cycles in significant fashion, underscoring why the asset class is returning to the spotlight.
Munis Over Treasurys
When it comes to allocating to low-risk bonds, there’s often a debate between munis and Treasurys. However, there might not be much of a debate at all because municipal bonds are better values today than their U.S. government counterparts. There are other reasons to consider munis.
“Long-term munis are becoming a viable alternative to treasuries. Long-term municipal bonds are emerging as a strong alternative to Treasuries,” notes Drew Anderson of VanEck. “Municipal bonds are exempt from federal taxes and, in some cases, exempt from state and local taxes. They typically offer solid credit quality and can provide a higher tax-equivalent yield compared to taxable bonds.”
Anderson highlights the rate sensitivity of the ICE Long AMT-Free Broad National Municipal Index (MBNL) – a popular gauge of longer-dated municipal bonds. The index’s duration to worst is 13 years, meaning that it could rise by 13% if interest rates decline by 1%. That’s something to ponder with some experts forecasting a drop in rates of 150 basis points by the second quarter of 2025.
Adding to the favorable history case for long-dated munis is the following. During prior Fed easing cycles, those bonds beat AAA-rated munis, broad baskets of municipal debt and Treasurys.
Election Could Signal Muni Opportunity
With Election Day fast-approaching, it’s possible that equity market volatility will increase, thus sparking inflows to lower volatility assets. Alone, that could indicate there’s opportunity afoot with munis, but there’s more to the story.
Pre-election volatility is one thing. The results are a different ballgame and the outcome could further enhance the allure of municipal bonds.
“Long-term munis offer competitive yields when compared to other fixed-income assets. Proposed changes in top marginal tax rates could increase demand for tax-exempt munis, especially with the potential sunsetting of the Tax Cuts and Jobs Act (TCJA) in 2025,” adds Anderson. “This would bring back a top marginal rate of 39.6%. The election could have a significant impact on munis, depending on how the future administration handles the top marginal tax rate. Former President Trump has previously suggested extending the TCJA, while Vice President Harris will likely let the TJCA expire.”
Related: Helping Clients Deal with Windfalls