By Regina Shafer, CFA
Senior Portfolio Manager of Tax-Exempt Investments
Every week for more than a year, money poured into U.S. municipal bond funds as income-starved investors pursued low-risk yield in a low interest rate world. That relentless demand overwhelmed the meager supply of new bonds coming onto the market, pushing muni prices up and muni yields down close to all-time lows.
These long-standing supply and demand trends took a turn recently. Cash flowed out of the muni sector at the same time issuance of new bonds climbed to the highest level of the year. It appears that some issuers may be rushing to get ahead of a possible December interest rate hike. Higher rates stand to be a negative for bond prices and would almost certainly raise borrowing costs for issuers.
Along with the prospects of a rate increase by the Federal Reserve, demand at the short end of the curve was lowered due to rules changes for money market funds, which have been large buyers of short-term munis.
As long-term bond investors, we invest for tax-exempt income and strive to look beyond the near-term impacts of the Fed’s next move. A muni market with more bonds, higher yields and fewer competing buyers to bid up prices is a major positive for us — it gives us the opportunity to be more selective in what we put into our portfolios. When we look out at the muni landscape, we like what we see — hopefully higher distributable tax-exempt income.
October is on track to be a record month for muni issuance, as new projects get funded and states and localities lock in low rates when refinancing their existing debt. We expect this upswing in supply will last a few months — December and January are historically key months for muni debt refinancing — before settling down again.
There is still plenty of cash in the market representing weeks of unmet demand, so we think there’s little chance of a glut that could seriously affect bond prices for a prolonged period. Munis are currently cheap compared to Treasuries, which should attract the attention of safety-minded investors seeking a yield advantage on a tax-exempt basis.
Speaking of supply, infrastructure spending gets a lot of attention these days, with both of the major presidential candidates making it a central component of their plans to kick up the languid pace of U.S. economic growth. We expect much of the large-scale infrastructure push would be funded via the muni bond market. This added supply may provide more buying opportunities at higher yields, again something we would welcome.
As always, we encourage investors to speak with one of our financial advisors, who can help determine which investment vehicles are best suited for you based upon your individual goals, objectives, risk tolerance and time horizon.
Investing in securities products involves risk, including possible loss of principal.
This material is provided for informational purposes only by USAA Asset Management Company (AMCO) and/or USAA Investment Management Company (IMCO), both registered investment advisors. The material is not investment advice and is not a recommendation, an offer, or a solicitation of an offer, to buy or sell any security, strategy or investment product. The views and opinions expressed in the material solely reflect the judgment of the authors, but not necessarily those of AMCO, IMCO or any affiliates as of the date provided and are subject to change at any time. All information and data presented herein has been obtained from sources believed to be reliable and is believed to be accurate as of the time presented, but AMCO/IMCO does not guarantee its accuracy. The information presented should not be regarded as a complete analysis of the subjects discussed. Any past results provided do not predict or indicate future performance, which may be negative. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of AMCO/IMCO and USAA.
Diversification is a technique to help reduce risk. There is no absolute guarantee that diversification will protect against a loss of income.
The fixed income securities are subject to price volatility and a number of risks, including interest rate risk. Interest rates and bond prices move in opposite directions so that as interest rates rise, bond prices usually fall and vice versa. Interest rates are currently at historically low levels. Fixed income securities also carry other risks, such as inflation risk, liquidity risk, call risk, and credit and default risks. Lower-quality fixed income securities involve greater risk of default or price changes. Securities of non-U.S. issuers generally involve greater risks than U.S. investments and can decline significantly in response to adverse issuer, political, regulatory, market and economic risks. Fixed income securities sold or redeemed prior to maturity may be subject to loss.
Investments in foreign securities are subject to additional and more diverse risks, including but not limited to currency fluctuations, market illiquidity, and political and economic instability. Foreign investing may result in more rapid and extreme changes in value than investments made exclusively in the securities of U.S. companies. There may be less publicly available information relating to foreign companies than those in the U.S. Foreign securities may also be subject to foreign taxes. Investments made in emerging market countries may be particularly volatile. Economies of emerging market countries are generally less diverse and mature than more developed countries and may have less stable political systems.
Investments provided by USAA Investment Management Company and USAA Financial Advisors Inc., both registered broker dealers, and affiliates.
Financial planning services and financial advice provided by USAA Financial Planning Services Insurance Agency, Inc. (known as USAA Financial Insurance Agency in California, License # 0E36312), a registered investment advisor and insurance agency and its wholly owned subsidiary, USAA Financial Advisors, Inc., a registered broker dealer.
236595 - 1016