After bouncing along at relatively unchanged levels for the first 15 days of May, tax-free municipal rates have been following the repricing of the Treasury curve over the last 5 trading days, and has, in our view, created some very intriguing taxable equivalent yields for high-income earners.
While our ultimate long-term view is still to extend duration, at opportune times, to lock-in rates in the intermediate part of the curve before the Federal Open Market Committee (“FOMC”) does move to more of a stabilization pattern and potential easing next year, we cannot ignore the levels of income that can be generated for the defensive-minded individual.
There is widespread recognition of what the debt-ceiling battle has done to the T-bill market, but we have also seen a well-functioning municipal market send yields higher in the 1, 2, 3-year maturities as well.
Taxable Equivalent Yields of the ICE 1-3 Muni Index and ICE 1-3 UST & Agency Index as of May 23 close
Source: Bloomberg
The other end of the spectrum is, of course, to take advantage of what could be a short-lived dislocation, and work out the curve and down a bit in credit quality. As we head into a potential recessionary environment, we have had many conversations regarding our Enhanced Intermediate Strategy as of late, and the overall credit quality of the municipal market vs comparable corporates. The rush to market by corporations, with over 100 bln of new supply coming in the last two weeks alone, and the ultimate rush of borrowing by the US Treasury once (if?) the debt ceiling is raised, makes the still shrinking exempt market seem conservative. As we have discussed many times, the credit fundamentals of municipals vs corporates, as well as default history, leans the way of tax-frees, but the ultimate size of the BBB space in the corporate market is too vast to ignore. Looking at single A tax-frees vs BBB corporates provides a decent picture of where things have gone as of late, and the taxable equivalent yield that can be generated for a long-term investor.
Taxable Equivalent Yields of ICE A Rated Muni Index and the ICE BBB Corporate Index as of May 23 Close
Source: Bloomberg
One thing that should be clear with the constantly changing expectations of FOMC actions, regional bank headlines, the tightening credit that may ensue, and of course, the theater in DC is that volatility in fixed income has not gone anywhere, and may be here to stay. But as we first began to highlight last year, the income portion of that fixed income portfolio, at least, now provides a ballast during these uncertain times.
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