Year to date, the municipal market has posted exceptionally strong returns of more than 7%. Investors have shown munis the love, driving 39 consecutive weeks of inflows that reflect solid and sustained interest. Nevertheless, low yields and an aging US expansion continue to top investors’ concerns as we enter the home stretch of 2019.
If there’s one theme that unifies muni investors’ questions and concerns, it’s how to resolve the tension between risk and return in increasingly uncertain conditions. And if there’s one overarching investment takeaway, it’s that active and flexible strategies can effectively balance risk and reward when conditions are evolving and visibility is limited.
With municipal bond yields so low, aren’t I better off investing in cash equivalents?
Whether they’ve been sitting on the sidelines for months or are contemplating a quick exit, some investors believe that municipal yields are too low to warrant staying invested. Instead, they’re turning to cash equivalents to provide the ballast they’d otherwise expect from muni bonds.
However, looking forward, the range of possible outcomes—stable, falling or rising rates—strongly favors staying invested, despite low yields. In Display 1, we’ve used a one-year US Treasury bill yielding 0.94% after taxes as a proxy for the earnings on cash over the next 12 months.
For investors to be better off parking their money in cash, municipal bond yields would have to rise, and their prices would have to fall, by an amount consistent with a rise in 10-year Treasury yields to more than 2%. That prospect seems remote in an environment of easing monetary policy and heightened equity volatility.
In addition, municipal bonds will likely continue to experience supportive technical conditions. Although supply has begun to increase as issuers take advantage of the decline in interest rates, demand remains very strong. Combined with all the other ingredients that led to a strong run in municipals year to date and that remain in place today—low global yields, an expanding (albeit decelerating) economy and a volatile equity market—favorable supply/demand factors suggest stable municipal yields and prices in the fourth quarter.