Municipal bonds have gotten so rich that investors may be better off buying US Treasuries.
(Bloomberg) — Municipal bonds have gotten so rich that investors may be better off buying US Treasuries.
The 10-year municipal benchmark offers just 62% of the yield on similarly-dated Treasuries, well below the historical norm, according to data compiled by Bloomberg. The figure, a key gauge of relative value in the market, has averaged about 85% over the last five years, the data show.
Most municipal bonds typically offer less yield than Treasuries because the income generated on those investments is exempt from federal taxes – but that yield differential now has gotten more extreme. Shorter-term debt, which is popular with retail investors, is considered even more expensive.
The muni market’s high valuations could deter some buyers. Already, cash and cash-like alternatives with high yields have acted as a competitor to state and local debt.
For investors who can buy securities outside of the municipal market, known as crossover investors, it can make sense for them to buy Treasuries instead, said Joshua Perry, partner and portfolio manager at Brown Advisory. “It’s a little bit too rich on the inside of the curve,” he said.
The two-year muni-Treasury ratio is about 59%, far below the five-average of roughly 86%, data compiled by Bloomberg show.
Investors looking to stay ultra short would be better-served buying Treasuries given the richness on that part of the curve, said Bryan Didonato, a portfolio manager at Abner, Herrman & Brock LLC. He said he thinks state and local debt will continue to stay expensive. “If you wanna go out a little bit longer and lock in some coupons and lock in some duration to your portfolio, you would buy municipal bonds.”
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Still, municipal bonds’ valuations compared to Treasuries is only one metric for investors to consider, said Terry Goode, senior portfolio manager at Allspring Global Investments LLC.
Yields have increased after years of staying low. One-year AAA debt, for example, yields 3%, compared to near-zero in 2021. And the Federal Reserve is seen as wrapping up its interest-rate hikes, which will benefit bonds broadly.
“When you look at absolute yields, absolute credit spreads and where we are in terms of the credit cycle, it’s a really good time to get invested,” Goode said. “You can buy really good credit at attractive yields. You don’t have to go way down in credit quality or go way down in coupon or buy different kinds of structures.”
For now, valuations may stay expensive in the summer given that the muni market sees few new bond sales as part of a seasonal trend.
“We expect valuations to reach some of the tightest muni-to-Treasury yield ratios of the year before becoming cheaper this autumn,” UBS analyst Kathleen McNamara said in a note.
–With assistance from Nic Querolo.
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