Municipal bonds have had a good run since the beginning of the year, but there’s still room for additional positive performance in 2019. That’s particularly true for investors who choose active strategies with the flexibility to move money around the bond market as conditions evolve.
As of late July, municipal bonds had returned 5.8% year to date and seen net mutual fund inflows of some $52 billion. We expect the strong demand and relatively weak issuance driving those returns to continue. This summer, bond calls and maturities are expected to exceed new issuance by $48 billion.
Against that overall positive backdrop, muni investors should keep three things in mind as 2019 winds down.
1. Think Carefully About Cash
Despite the technical factors driving muni performance and the fact that muni bond investors will receive $45 billion in coupons this summer, some investors are still parking money in cash and wondering if it makes sense to buy when yields are so low. Our research shows that a portfolio of intermediate-duration munis would outperform cash in most scenarios.
The 10-year US Treasury yield would have to climb to 2.54%—up from 2.07% as of July 26—for one-year returns on intermediate municipal bonds to break even with returns on one-year Treasury bills, a proxy for cash (Display 1).
With central bank easing on the horizon, rising rates are less of a concern for many investors now than they were a few months ago. However, should the Federal Reserve change its stance again, it’s worth noting that municipal bonds held steady even when rates were rising quickly. Intermediate-duration municipal bonds have held their value as the Fed hiked rates seven times between July 2016, when 10-year yields touched a low of 1.37%, and November 2018, when they topped out at 3.24%.