Muni Bonds Jump on Haven Rally

Ladies and gentlemen, listen up! The municipal bond market is ON FIRE! If you're a U.S. taxpaying investor, you need to pay attention because this is a once-in-a-lifetime opportunity. The yields on municipal bonds are skyrocketing, and you don't want to miss out on this haven rally. Let's dive in and see why muni bonds are the hottest ticket in town right now.



Why Muni Bonds Are the Place to Be

1. Yields Are Through the Roof!
- The Bloomberg Municipal Long Bond (22+) Index is yielding about 6.91% on a yield-to-worst, tax-equivalent yield (TEY) basis. This is a rare moment, folks! Historically, when yields have breached 7%, the 12-month forward return (TEY) has exceeded 5.50%, and the 24-month forward returns have reached 12% (TEY). This is a no-brainer! You need to lock in these yields now!

2. Tax Advantages Galore!
- Municipal bonds are tax-exempt, which means you keep more of your hard-earned money. For investors in higher tax brackets, this is a game-changer. The yield on the Bloomberg Municipal Bond Index was 3.4% as of December 3, 2024, which is equivalent to roughly 7% for a fully taxable bond for an investor in the top federal tax bracket in a high-tax state like New York or California. Are you really going to sit on cash when you can get these kinds of returns?

3. Strong Credit Backing!
- Municipal bonds are backed by the "full faith and credit" of the issuer, which has the power to tax residents to pay bondholders. This provides a strong credit backing, making municipal bonds a good option for risk-averse investors. You need to own these bonds!

The Risks You Need to Know

1. Interest Rate Risk!
- With the Federal Reserve having cut interest rates and cash rates expected to decline further, investors should be cautious about extending duration. However, the municipal yield curve flattened during the fourth quarter, reflecting stubborn inflation and shifting U.S. Federal Reserve policy expectations. Despite outsized high-grade municipal bond supply, municipals outperformed both Treasury bonds and corporate bonds. This suggests that current valuations are an attractive entry point for long-term investors.

2. Tax Policy Uncertainty!
- The incoming Trump administration is likely to propose a significant tax package early in 2025, given the impending expiration of numerous individual tax provisions from the 2017 Tax Cuts and Jobs Act (TCJA). This could impact the attractiveness of municipal bonds. For example, extending the current marginal tax rate levels for high-income earners and the cap on deductions for state and local government taxes (SALT) could affect the tax-equivalent yield of municipal bonds.

3. Credit Risk!
- While municipal bonds are generally considered safe, there is still a risk of default. For instance, general obligation bonds are backed by the issuer's taxing power, but revenue bonds are not backed by the government's taxing power but by revenues from a specific project or source. If the revenue stream dries up, bondholders may not have a claim on the underlying revenue source.

4. Call Risk!
- Many municipal bonds are "callable," meaning the issuer can repay the bond before its maturity date if interest rates decline. This can be a risk for investors who want to hold the bond to maturity.

The Bottom Line

Municipal bonds are the place to be right now. The yields are through the roof, the tax advantages are unmatched, and the credit backing is strong. But you need to act fast because these opportunities don't last forever. The market is well-positioned to begin the first quarter of 2025, with supply increasing meaningfully in 2024 and expected to remain robust in 2025. The January effect may act as a catalyst for momentum during the first quarter, with abundant coupons, calls, and maturities signaling strong reinvestment demand. Credit spreads remain attractive, at 181 basis points above the AAA municipal yield for high yield municipal bonds, offering investors an attractive entry point. The strong credit backdrop and the potential for spread compression make municipal bonds a compelling investment option.

So, what are you waiting for? Get in the game and buy muni bonds now! This is a haven rally you don't want to miss. BOO-YAH!