The tax-free municipal market has been on quite a run.
Driven by a solid technical backdrop, where inflows into the market have outpaced net supply, municipal valuations have reached extreme levels. One common way to judge the attractiveness, or lack thereof, of municipal bonds versus taxable bonds is to compare the yield levels between the two. For example, when analyzing the yield of a AAA-rated municipal bond versus a U.S. Treasury of a comparable maturity, we get a sense for how much investors are paying for the tax-free interest munis generate.
As seen in the chart below, this Muni/Treasury yield ratio has declined rapidly over the past several months, particularly for bonds with longer maturity dates.
This market action has helped support the solidly positive returns in our municipal strategies this year. It has also led us to take profits in munis in our Blend strategy, by selling munis and reinvesting the proceeds into taxable bonds such as US Treasurys and corporates.Related: How to Begin Incorporating ESG and Impact Investing into Your Portfolio? Try Munis
We are expecting the positive environment for munis to remain throughout the summer as June, July and August typically have the largest disconnect between supply and demand. However, for investors in mid-level tax brackets or for those without a state income tax to contend with, selling munis now and investing into taxable bonds provides added portfolio diversification without much of an after-tax income hit, making it an attractive trade for us.Source: Barclays