Muni Bonds ‘On Sale’

For most of the last decade, low supply of tax-free bonds and low yields were a predicament for investors. Today, the $4 trillion municipal bond market is a buyers’ market. Muni bonds are ‘on sale’, a favorable long-term investment opportunity.

Vibrant Primary Muni Market Lures Investors…New muni bond issue prices are generating strong investor interest. “Primary market deals continue to be priced cheaply enough to really attract a lot of interest,” an expert told Bloomberg “It’s a function of underwriters not wanting to be long bonds in the secondary market. They’re pricing deals on the cheap side in the primary market to make sure there’s enough demand.” For example, a Texas school bond rated ‘AAA’ with a Permanent School Fund guarantee priced long-term bonds at a 4.3% yield, about 70 basis points higher than similar top-rated bonds. Another expert said “overall, the primary market continues to provide excellent opportunities to put cash to work.”

Tax-Free Yield Advantage…Muni yields are at their highest levels in years, offering significantly better compensation than in recent history. A surge in borrowing by states and local governments has led muni bonds returns to underperform U.S. Treasury returns. Current tax-free benchmark yields are about 100 basis points higher than 10-year average yield. ‘BBB’-rated municipal bonds offer about 91 basis points of additional yield relative to top -rated muni bonds. High earners recognize that the taxable equivalent yield of top-rated muni bonds exceeds comparable U.S. Treasury yields by 160 basis points. This year, Top-rated muni bond yields have ranged from 3.46% (08/05/24) to 4.01% (4/30/24). Often, volatile market conditions are opportunities for long term investors to lock in higher tax-free income and expect favorable returns as policy rates decline.

Bullish Outlook For Long Term Muni Bonds…Consider investing in long- term municipal bonds, as they offer investors higher tax-free income. Lower policy rates favor returns on long term bonds. Additionally, longer-dated muni bond prices adjust higher with the passage of time if market yields remain the same. For example, 30-year maturity is likely to be priced similar to bonds maturing in twenty-five after five years, a ‘roll down return’. Muni bond gains could accelerate as inflows to bond funds gather pace. This year, top-rated muni bonds have posted 1.3% index returns, relative to 6.4% index returns in 2023 and an 8.5% loss in 2022.

Mega Muni Bond Sales Record High …Billion dollar plus muni bond transactions are at a record high this year. Florida’s Brightline trains, Dormitory Authority of State of New York, JFK Airport are among issuers who sold mega muni bonds. Colleges accounted for about one-in-four new bond sales this year. Increased mergers and acquisitions in the healthcare sector led hospitals to ramp up bond sales. Airport bond sales have soared as passenger traffic exceeds pre-pandemic levels, calling for plant upgrades.

Muni Bond Prices Are A Bargain…State and local-government bond valuations are currently at their lowest point this year. The Muni-Treasury ratio, a key gauge of relative value, is at its highest level this year, indicating that municipal bonds are relatively more appealing. The higher the Muni -Treasury ratio, the more attractive tax-free muni bonds are compared to taxable counterparts. Long term top-rated municipal bonds offer about 88% of the yield on similar Treasuries, up from 82% this spring. JPMorgan Chase strategists said last week “The next two months could offer the best opportunity to buy bonds of the year and possibly the rate cycle.”

Muni Bond Issuance At Decade High…Muni bond sales have hit $334 billion this year, the most in over a decade. Texas issuers have issued the most muni bonds this year, followed by California and New York. Over 8% of muni bonds issued this year were insured by Assured Guaranty or Build America Mutual. Several governments refinanced taxable Build America Bonds to reduce exposure to political uncertainty of federal interest subsidy appropriation.

Front-Loaded New Issue Calendar…State and local governments are rushing to put out new issues ahead of the November presidential election to avoid the market volatility that could follow. Sophisticated investors will likely to put cash to work when the calendar is heavy, recognizing that bond issuance could be lower closer to the elections. A vibrant primary market and attractive bond prices are enticing investors to buy muni bonds.

Municipal Bond Demand Grows…Last weeks’ inflows to muni bond funds, a barometer of investor demand, were the highest since February, per ICI data. During 2022 and 2023, mutual funds sold massive amounts of muni bonds to meet redemptions driven by policy rate hikes. For nine straight weeks, muni bond funds have received cash inflows. Long term muni bonds are most sought. With a Fed rate cut imminent, investors and experts reckon now is a good time to lock in the high tax-free yield.

Rating Upgrades Surpass…Roughly 94% of state and local government bonds are rated investment grade assets. Rating upgrades have outpaced downgrades this year. Transportation and infrastructure sector account for the most upgrades, while higher education and healthcare sectors have borne the brunt of rating downgrades. The credit quality of municipal bond issuers has been boosted by continued economic stability and stronger government finances. In certain sectors, credit differentiation is crucial as the gap between larger and smaller organizations’ financial performance has widened. Several U.S. states’ credit rating surpasses the United States’ sovereign rating.

Election Uncertainty…Without action from Congress, trillions in tax cuts will expire after 2025 and raise taxes for most Americans. The $10,000 cap on the federal tax break for state and local taxes, known as the SALT deduction will also sunset after next year. Although lawmakers have barred municipalities from issuing tax-free bonds to refinance debt before their call date, federal tax-exemption on muni bonds has remained intact. Amid rising federal budget deficits, subsidies to states and local governments will remain front and center. There are concerns that some policies of presidential candidates could be inflationary. Federal policy affects all corners of the bond market including credit risk and tax implications.