The View from Muniland: Once in a Generation

Jason Mertz: Daryl, it feels like Groundhog Day, with yet another challenging quarter for muni investors. The index was down about 4%, bringing year-to-date returns to –1.4% for the year. So what happened in August and September?

Daryl Clements: There’s a couple of things you could point to, the first being the constant drumbeat from the Fed of higher rates for longer. Also, the Fed recently removed two rate cuts next year. And then it's just the expectation of more Treasury issuance.

JM: But the economic landscape has certainly changed.

DC: So, you go back a year. The Fed funds rate was about 2.5%; today it's 5.5%. Inflation was running over 8%; now it’s less than 4% with core inflation, core CPI, at 2.5%. So, the economy is clearly slowing.

JM: The Muni Bond Index is yielding [the] highest it's been since 2007, 4.33%. On a tax-equivalent basis for someone in the highest tax bracket, that's north of 7.25.

DC: Oh, it's clearly an opportunity. Yields are as high as they've been in a generation, basically. If you expect yields to fall over the next 12 months, you want duration, because that will provide a boost to your total return.

And within that, you want to be mindful of your maturity structure. The municipal yield curve has a wonky shape, it's kind of a U shape. So, if you barbell around that, if you buy a 15-year bond and a one-year bond in equal amounts and compare that to the yield of an eight-year bond, you'll have a higher yield, but with the same interest-rate sensitivity.