Bonds

Munis can offer 8% taxable equivalent yields if investors dive in now

The last time the triple-A 30-year muni was consistently over 4%, Barack Obama was president, lawmakers were squabbling over whether to raise the debt ceiling, cut spending and keep the federal government open, which eventually resulted in a downgrade of the United State’s triple-A rating by S&P Global Ratings.

While there is a different administration, certain dysfunctional factors are still at play in Washington, as lawmakers are again at loggerheads on spending, the debt ceiling and whether to keep the government open. The U.S. lost another triple-A rating, this time from Fitch Ratings.

Adding in major macroeconomic uncertainties and severe geopolitical turmoil, volatility has been the theme for bond markets.

As participants have worked through various challenges, muni “yields are the highest in over a decade and ratios, though not cheap, are attractive,” said Chris Brigati, most recently senior vice president and managing director of municipal strategy at Valley Bank in Morristown, New Jersey.

Chris Brigati, head of municipal trading at Advisors Asset Management

“If you haven’t already, it’s worth starting to dip a toe in the water,” he said.

In the summer of 2011, interest rates for the triple-A, 30-year municipal yield were as high as 4.35% on June 30, according to Refinitiv MMD. The same benchmark was yielding 4.36% on Tuesday, falling to 4.24% as of Friday. That is up significantly from four months earlier when it was yielding 3.49% on June 30.

Outside of triple-As, elsewhere in the high-grade spectrum, yields are even more attractive, Brigati noted. On Friday, double-A rated municipal yields were at 4.55% and the single-A rated yield was at 4.79%, according to Refinitiv. The 30-year U.S. Treasury was at 4.79% Friday morning.

The recent rise in yields has created an opportunity for those investors waiting to “jump into the market,” Roberto Roffo, portfolio manager at SWBC Investment Company, said Wednesday.  

“While ratios show that municipal bonds are approximately 90% of Treasuries, buying double-A or even A-rated bonds allows investors to purchase bonds cheaper than current Treasury bonds,” Roffo said.

“Considering that municipal bonds are the second safest fixed income asset class behind Treasuries, investors are taking minimal risk to achieve tax-free yields above Treasuries,” Roffo said. 

With the taxable equivalent yield taken into account, it makes municipal bonds look even more attractive, he noted.  

For example, an investor in the top tax bracket purchasing an A-rated bond at a 5.25% yield will earn a tax-equivalent rate of approximately 8.70%, Roffo pointed out.  

“Considering the safety of municipal bonds, no other asset class comes close to being so attractive” in the current market, Roffo added.

Others agreed the taxable equivalent yield offered by attractive investment-grade municipal paper speaks volumes in terms of value and opportunity.

Michael Pietronico, chief executive officer at Miller Tabak Asset Management, called the opportunity “a generational buy in our view.”

“As intermediate buyers out to only 15 years on the yield curve, we are enjoying locking in 5% tax-free yields when they show up in the secondary market,” he said Wednesday.

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“That yield brings the taxable equivalent yield to almost 8%, which covers the current rate of inflation quite well,” Pietronico added. 

The current yield range allows investors to take advantage of both a historic and cyclical opportunity, Brigati said.

“Municipal yields have been playing catch-up with Treasuries and are gapping wider, as is typical in the September/October time period,” he noted.

Brigati said investors can lock in better than 7% tax-equivalent yield on high-grade municipals in the current market. 

Municipals tend to get cheaper in the fall, but besides the cyclical opportunity, absolute municipal yields have cheapened 30 basis points more than Treasuries in the last few weeks, Brigati noted.

Brigati expects this buying trend could potentially last through year end, and 5% coupons at par could become readily available.

“It’s a cyclically interesting time relative to other times of the year,” Brigati said.

“It tends to be a little bit of a supply-demand dynamic,” he said.

“The market is cheaper because there is more available to buy,” Brigati added.  Thirty-day visible supply is at more than $16 billion, per The Bond Buyer data.

One of the popular structures that retail investors like in the current market is 5% coupons that are trading at yields in the ballpark of 4.75% to 4.90%, according to Brigati.

“It’s a historically interesting time for retail buyers who prefer 5% bonds at a discount to par, or at par, and we’re close to being there,” he said. 

With an inverted yield curve in the municipal market, investors are trending toward extending their maturities to take advantage of the current yields.

“People want to lock in down the curve,” as the “sweet spots” are 10 to 15 years with three- to seven-year calls, and 15 to 20 years with a 10-year call.

“That is an attractive spot and where a lot of people are trying to participate,” he said of the 15- to 20-year slope. Investors, he noted, can earn close to 5% yields and lock those yields in with the added protection of a 10-year call. 

“There has not been an opportunity to do that in quite some time,” Brigati said, reiterating the decade-long gap in attractive yields dating back to 2011-2012.

That was before the Federal Reserve Board’s zero interest-rate policy to promote economic stimulus, and long before the COVID pandemic, he noted.

“They were in a stimulating environment and aggressive in doing anything they could to keep the economy stimulative,” Brigati said of the Fed.

That 10-year rally ended in 2022 when the central bank started raising short-term rates, and became much more defensive, Brigati noted.

“They were raising rates and that caused the yield curve back up, as a result, and created a buying opportunity for investors not seen in a long time,” he said. 

According to Brigati, investors should grab the chance to earn attractive yields now, as he said the advantageous climate might stick around only through early November.

“It’s not a two- to four-day thing,” he said, noting that the timing of the window of opportunity depends on the upcoming Fed meetings, the next of which is scheduled to end on Nov. 1.

The Federal Open Market Committee held rates steady during its most recent meeting in September.

The FOMC raised interest rates to 5.25%–5.50% at the July 2023 meeting, marking 11 rate hikes this cycle aimed at curbing high inflation.

“This is a bigger-picture, cyclical thing,” Brigati said of the attractive yield climate.

“Investors should dip their toe in in case the Fed has done enough and feels comfortable with rates,” Brigati said. “That could cause the yield curve to rally.”

On the flipside, if the Fed does not come out with a stance, and they raise interest rates to 7%, the buying opportunity will get even better as rates increase, according to Brigati.

That is the chance investors have to take, he said.

“Are you getting in early; could they get more attractive?” Brigati asked.

The answer to both questions, he said, is yes.

But, if historical patterns prevail, most investors believe that locking in 5% tax-free yields for high-grade paper is attractive.

He said investors who allocate some money into the current market can always take advantage of the cyclical and historical benefits and tweak their game plan later.

Besides the beneficial yield climate, Brigati added, it is also a good time for investors to consider tax-loss swaps.

“They can use the losses in their portfolios to harvest them toward gains in the stock market,” Brigati added.

This will allow investors to reestablish their portfolio at the current absolute higher yields and prepare for the future.

“They will be buying attractive bonds at attractive levels on longer-duration, higher yields, while swapping tax losses with equity gains,” he said.

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