Market Update – Seasonal Tailwinds and Easing Interest Rates
Jun 10, 2024
After a solid 2023 in which the Bloomberg Municipal Index was up over 6% (including a positive 8% in November and December), it’s been a slow start to the year in 2024. Changing Federal Reserve (Fed) rate cut expectations and already rich relative value ratios (versus Treasury yields) have, so far, offset still high tax-equivalent yields and solid fundamentals for the asset class. But with the unofficial kick-off to summer behind us, the muni market, we think, is set up for a number of potential tailwinds that could help push the index back into positive territory by yearend.
- Summer redemption season is about to start. While the new issuance calendar will likely remain robust over the next month or so, muni investors will be receiving $42 billion of principal and $13 billion of interest in June (up from $22 billion of principal and $11 billion of interest in May). An additional $34 billion in principal is slated to be paid out in July and $43 billion in August. Redemption amounts, if reinvested (as they usually are), will help provide price stability to the market.
- As illustrated in the chart below, despite strong performance in 2023, the index yield-to-worst (YTW) at 3.93%, or 6.63% on a taxable-equivalent basis, remains above its longer-term average. The elevated nominal yields and income opportunities offered by the muni market remain above the levels over much of the past decade.
Starting Yields are Still Attractive
Bloomberg Municipal Bond Index Yield and TEY are Above Long-term Averages
* Assumes tax rate of 40.8%
Source: LPL Research, Bloomberg 05/31/24
Disclosures: All indexes are unmanaged and cannot be invested into directly. Past performance is no guarantee of future results.
- Fundamentals for the asset class are healthy as well, as many municipalities continue to sit on ample rainy days and reserve funds. And though tax revenue collections are likely past peak levels, they remain healthy and above pre-pandemic trends. Even in a scenario in which the economy slows meaningfully, ample cash reserves on hand make defaults unlikely. Historically, the default rate for municipalities is extremely low and with positive fundamentals, downgrades and defaults will be limited, in our perspective.
- The wild card, in the near term, is the broader macro environment and the potential for Fed rate cuts. While economic data has shown signs of softening, inflationary pressures are still too high to warrant an aggressive rate-cutting cycle, at least right now. However, if the inflation story continues to improve, the Fed may be able to start to slowly reduce the fed funds rate, which would provide a tailwind to muni prices.
While the slow start to the year may be frustrating to some muni investors, we think the outlook remains positive. With the positive summer technicals upon us, coupled with still attractive starting yields and solid fundamentals, the second half of 2024 could be a positive one for muni investors (no guarantees of course). But even if interest rates don’t fall from current levels, the income opportunities within the muni universe are as attractive as they’ve been in decades.
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IMPORTANT DISCLOSURES
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing. Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk. Indexes are unmanaged and cannot be invested into directly. Index performance is not indicative of the performance of any investment and does not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results. This material was prepared by LPL Financial, LLC. All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy. Unless otherwise stated LPL Financial and the third party persons and firms mentioned are not affiliates of each other and make no representation with respect to each other. Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. Asset Class Disclosures – International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets. Bonds are subject to market and interest rate risk if sold prior to maturity. Municipal bonds are subject and market and interest rate risk and potentially capital gains tax if sold prior to maturity. Interest income may be subject to the alternative minimum tax. Municipal bonds are federally tax-free but other state and local taxes may apply. Preferred stock dividends are paid at the discretion of the issuing company. Preferred stocks are subject to interest rate and credit risk. They may be subject to a call features. Alternative investments may not be suitable for all investors and involve special risks such as leveraging the investment, potential adverse market forces, regulatory changes and potentially illiquidity. The strategies employed in the management of alternative investments may accelerate the velocity of potential losses. Mortgage backed securities are subject to credit, default, prepayment, extension, market and interest rate risk. High yield/junk bonds (grade BB or below) are below investment grade securities, and are subject to higher interest rate, credit, and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors. Precious metal investing involves greater fluctuation and potential for losses. The fast price swings of commodities will result in significant volatility in an investor's holdings. Securities and advisory services offered through LPL Financial, a registered investment advisor and broker-dealer. Member FINRA/SIPC. Not Insured by FDIC/NCUA or Any Other Government Agency | Not Bank/Credit Union Deposits or Obligations | Not Bank/Credit Union Guaranteed | May Lose Value
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