Municipal bond investors like their muni portfolios to play the role of Old Faithful in their overall asset allocation, providing safety and income. But that doesn’t mean that the investment environment is reliably the same. How can muni investors stay on track in 2019? They can adhere to these three strategies.
1) Stay invested. The outlook for muni bonds in 2019 is favorable. This is partly because the supply/demand picture for municipal bonds is exceptionally supportive of prices, with net supply likely to be negative in 2019. Investors who stay on the sidelines during supportive supply conditions will miss out on a potential rally.
Also, we expect the pace of rising rates to slow, as the Fed has become more dovish. Since late 2015, the Fed has hiked the federal funds rate nine times, to a range of 2.25% to 2.50% today. That puts the level of rates now into nearly neutral territory relative to the healthy growth of the US economy. In response, Fed Chair Jerome Powell recently indicated that there will likely be just two rate hikes this year. He also characterized the current Fed mindset as “patient and flexible,” reflecting a more data-dependent approach as we near a rate that neither boosts nor slows the economy.
The upshot is that yields will probably rise modestly this year.
Municipal bond portfolios can defend against the associated price decline by slightly reducing their average portfolio duration, or interest-rate sensitivity. And bear in mind: with yields already higher than at this time in 2018, the income generated by muni bonds creates an ample cushion for further modest increases in yield. Concentrating high-grade bond holdings more heavily in short and intermediate maturities while underweighting more vulnerable long-maturity bonds should also help.
In other words, investors are unlikely to be rewarded for shortening their maturity targets in 2019. And if the economy does soften more than we expect, municipal bond holders will be happy to have stayed invested.