Muni Catchup 6/6
Welcome to Pat Luby’s Muni Catchup for June 6, 2016.
Wow! What a difference a day makes! With the weak unemployment report on Friday, market consensus appears to be that a June rate hike by the Fed is not likely. (Click here to read Bloomberg’s analysis.)
Bond yields reacted by dropping–a lot! In the 5-year spot, muni yields declined by 2 Basis Points (100 Basis Points equals 1 percent), while U.S. Treasuries dropped by 13 BPs. In 10-years, the decline was 2 BPs for munis and 10 for USTs. Thirty yield yields also moved lower, by 5 BPs for munis and 6 for USTs. It is not surprising that the largest moves were in the short-to-intermediate parts of the curve, since historically, changes in monetary policy have had greater influence on the shorter end of the yield curve, while the long end of the curve tends to react more to changes in inflation expectations.
Investors often draw an artificial line in the sand at 10-years, and will not extend into maturities beyond that spot on the curve. As a result, there can be an over-concentration of demand that gets crowded into the 10-year maturity, creating an extra bump-up in yield for going slightly longer than 10-years. Right now, the inflection point–where incremental yield tapers off–can be seen in the 15-to-17 year range. ( See the Yield Comparison graph on the Context page.)
Extending beyond that point offers less incremental yield for taking on the additional Duration risk. As a general guide, it is helpful to pay attention to what percentage of the yield curve is captured by specific spots on the curve. Right now, it looks like this:
This doesn’t mean you should focus on one of these spots, but it can be a helpful point to keep in mind as you balance risk and return.
The further out you go on the curve, the cheaper that munis become relative to U.S. Treasuries, so it would not be surprising to see some increased muni buying from crossover buyers or non-U.S. fixed income investors.
Investors who have had principal returned from June 1 redemptions may be feeling anxious with the decline in yields–if the right bonds are not immediately available, it may make sense to maintain your exposure to the investment class by using muni bond ETFs. If you haven’t used muni ETFs, read about How to Pick the Right Muni Bond ETF and also Duration as a Guide With Muni ETFs so that you can maintain a similar risk exposure.
The next regular Muni Catchup is scheduled for Monday, June 13, but there are a couple of specials planned over the next two weeks, so if you are not already subscribed, be sure to sign up to be notified by email when new items get published.
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The opinions expressed and the information contained herein are based on sources believed to be reliable, but accuracy or appropriateness is not guaranteed. Past performance is interesting but is not a guarantee of future results. Investments in bonds are subject to gains/losses based on the level of interest rates, market conditions and credit quality of the issuer. Indices are not available for direct investment, although in some cases, there may be ETFs available designed to track some of the indices shown. The author does not provide investment, tax, legal or accounting advice–this is NOT investment advice. Investors should consult with their own advisor and fully understand their own situation when considering changes to their strategy, tactics or individual investments. Additional information available upon request.