Economic uncertainty remains. The macroeconomic backdrop continues to be one that is hard to characterize but U.S. economic growth remains positive, although it was revised slightly lower at the end of May. The U.S. economy has been stubbornly resilient. This resilience caused U.S. Fed officials to hold the overnight target rate steady between 5.25% and 5.50% for a seventh consecutive meeting, and the Fed also updated their dot plot unexpectedly, now showing they only anticipate one rate cut in 2024. Please see Bonds Retreat as Fed Signals Patience from June 12, 2024 by HilltopSecurities Senior Portfolio Managers Scott McIntyre and Greg Warner.
Political uncertainty also remains. Geopolitical threats linger in Eastern Europe and have risen in the Middle East. Many investors remain concerned about the potential results from the November 2024 elections in the United States.
We are looking for ways to help investors isolate their investment choices from the economic and political uncertainty that exists now. We are also looking for ways investors can exploit the opportunity that exists because the Fed may have acted too slow to lower its target rate. Absolute tax-exempt yields remain attractive. We have been consistently making the case for tax-exempt municipal bonds, especially going back to the beginning of the summer of 2023. We are reiterating that argument now, particularly because it is a way investors can isolate themselves, somewhat, from macroeconomic and political uncertainty.
Where the U.S. municipal bond market is concerned, we continue to mostly see a very strong level of credit quality. This is principally evident where tax-backed credits are concerned. And as the first half of 2024 comes to an end, we continue to see generationally attractive absolute tax-exempt yields. Investor sentiment is a little more positive than we saw in 2022 and 2023, but investor enthusiasm has not been substantial during the first six months of the year.
Even though credit remains very strong, and we continue to see generationally attractive tax-exempt yields, some investors are still sitting on the sidelines watching as an important tax-exempt fixed income opportunity potentially slips away. What have municipal bond investors been missing, if they have not been active in the market in the last year?
Historically Attractive
A little over a year ago, on June 8, 2023, we highlighted the opportunity in tax-exempt municipal bonds for investors to consider because we were seeing “historically attractive” yields. We noted, “Now is a perfect time for fixed income investors to review their portfolios and replace weaker holdings.” Upgrades outpaced downgrades in the first half of the year (and they did so in all of 2023, and in the first quarter of 2024 as well).
Amazing Opportunity
In a June 20 appearance on CNBC, I again noted the “amazing opportunity” for investors, “not only because of the technical side and where yields are, but I really can’t remember when credit quality was as strong as it is right now.”
Peaking Yields
Then, in September 2023, we reiterated our assessment. In commentary published on Sept. 19, we wrote “peaking yields and attractive relative value measures are adding to our improved municipal bond confidence. It has been prudent for investors to tactically allocate investment dollars into the municipal bond market on a regular basis this year.”
Generationally Enticing
A month later, investors were still holding back, despite the continued positive outlook. We wrote on Oct. 11, 2023, “Conviction for municipal bond investing should be stronger considering the market dynamic and very strong credit quality (and Golden Age of Public Finance).” We noted yields remained “generationally enticing,” and that “future investment opportunities as attractive as this for municipal investors may occur, but the opportunities will be less frequent.”
Running Out of Synonyms for Appealing, Attractive
On Nov. 1, 2023 with yields near their peak, I intensely reiterated during the first installment of the Muni Minute I recorded with John Muschalek, HilltopSecurities Head of Wealth Management, that I was running out of synonyms to describe the level of opportunity available to municipal investors. “Yields have been high, they continue to be high, … and even though there is some negative investor sentiment out there, I still think they are very attractive.”
Yields Remain Appealing
Even though tax-exempt yields dropped in the final two months of 2023, we highlighted they “Remain Generationally Attractive in Feb. 2024” in our Municipal Bond Investor Playbook for the Rest of the First Quarter, 2024.
Golden Age Not Over
We wrote, “The Golden Age of municipal bonds or public finance is still not complete.
However, yields will not always be this appealing and credit will not always be this robust,” in our March 25, 2024 report The Golden Age of Municipal Bonds is Not Over.
Yields and Tax-Exempt Status Attracted Demand
In April 2024 John Muschalek and I discussed how the Golden Age of municipals is winding down, yet rising yields attracted individual investor demand for tax-exempts. You can see the sixth episode of the HilltopSecurities Muni Minute #6- A Jump in yields and Tax-Exempt Status Drives Steady to Strong Retail Demand of Municipal Bonds here.
Strong Value & Improving M/T Ratios
“Municipals look better on a relative value basis,” wrote Chris Nicholl, HilltopSecurities Senior Portfolio Manager in his June 4, 2024 Muni MOment market update, Municipal Ratios Improve While the Fed Sees Slow Progress on Inflation.
And finally at the beginning of June 2024, during the most recent Muni Minute #7 segment The Window of Opportunity for Tax-Exempts Remains “Open,” I recorded with John Muschalek, I highlighted the tax-exempt bond opportunity that is even more attractive now than it was at the beginning of 2024. We discussed that a window of opportunity began to open at the beginning of March, but it is important for investors to recognize that window of opportunity could close, and close quickly.
The Window of Opportunity for Tax-Exempt Municipal Yields Opened Again in March 2024
Again, investor sentiment has slightly improved in the first six months in 2024. However, it seems there are many explanations for the hesitancy to take advantage of the opportunity presented by the current strong municipal credit outlook and attractive yields. This includes the impact of some major developments over the past two years, including the Fed’s rate increases to fight inflation, Russia’s invasion of Ukraine, regional banking stress, Middle East geopolitical conflict, and even uncertainty surrounding the upcoming November 2024 elections in the U.S.
When the Fed signals it is beginning to shift its outlook, more investors could (finally) try to get ahead of the official Fed pivot. Once the rush for fixed income starts, I expect investor dollars will quickly flow back into municipal mutual funds, and demand could return to the more enthusiastically positive levels we saw in 2019, 2020 and 2021. If that scenario does play out, it will become increasingly difficult to find the right bonds to add to fixed income portfolios. The line chart above shows where absolute yields are now compared to 2021 and 2022. Therefore, our message to investors continues to be they should not wait for more certainty.
Source: Bloomberg and HilltopSecurities
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