2023 Update on Municipal Bonds

Municipal bonds have displayed remarkable resilience amid rising interest rates so far, outperforming most yield-related assets. They even weathered the recent government shutdown scare without much ado.

Image Source: Bloomberg BVAL, 'AAA Municipal Bond Yield Curve (0-40 years), accessed October 3, 2023.

Currently, municipal bonds are offering yields at 78% of their Treasury counterparts, which falls within the lower range of historical trends. While it's challenging to pinpoint the exact reason, some may attribute this to a flight to quality. Regardless, considering the broader interest rate context, their stability is noteworthy. For example, the 20–30-year Treasury bonds have declined over 12% year-to-date, including dividends. The MUB ETF has seen a modest decline of -1.8%, including dividends.

Timing plays a significant role in these matters, but presently, we are identifying attractively priced, high-quality municipal bonds. For instance, we've been acquiring municipal bonds with current yields ranging from 3.75% to 4% for short-term maturities and around 5% for mid-term options. Eventually, it will likely become more appealing to explore longer-term bonds. We've been patient in our bond purchases, prioritizing the highest ratings coupled with the best yield offerings. While it may take time, we believe this patience will pay dividends. Tien San Lucas, a Senior Analyst, has done a great job finding and trading these securities.

Image Source: Bloomberg BVAL, 'MUNSMT10 Index from January 1, 2000, to October 2, 2023,' accessed October 3, 2023.

The overall yield curve has begun to flatten out over the past two weeks, reflecting the rise in longer-term bond yield, likely due to stronger economic indicators. Moreover, the yield curve has improved from a steep -100bps to a more moderate -22bps.

 Additionally, fewer bonds are being called. This is a change from the low-interest-rate environment of previous years, and most liked due to interest rates being at a 17-year high. At this point, we believe that bonds with coupons of 4% or more are more likely to be called, although such instances are rare for older issues.

For clients who have been waiting for an opportunity to invest in high-quality municipal bonds, the current environment presents an auspicious window. Regrettably, those who made purchases 3-5 years ago may find themselves underwater on their principal investments, but we remain committed to exploring avenues to enhance their positions whenever possible.

Please don't hesitate to reach out to our team, if you have any questions or require further clarification.

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