The yield on the 30-year hit a multi-decade high this week, spiking amid continued fiscal and monetary concerns. The 30-year hitting 5.45%, its highest mark since 2004, comes amid an already busy year for bonds. Muni bonds, in particular, have seen major issuance and opportunity for long-term investments, an opportunity set explored recently by American Century Investments Vice President and Senior Portfolio Manager Joe Gotelli.
Key Takeaways:
- With yields reaching multi-decade highs, bond categories — like munis — offer opportunities.
- The 30-year muni-to-Treasury ratio reached 93% compared to 88% for the trailing one-year average.
- Muni bonds offer long term opportunity and a solid entry point for those with available capital.
Gotelli, who joined the firm in 2008, spoke to the shifting relative value of muni bonds. According to Gotelli, where earlier this year muni markets saw a slight amount of richness, with robust supply meeting robust demand, that landscape has changed. Now, he explained, with absolute yield levels resetting amid notable rate volatility, yields have spiked.
“In the last week or so, we’ve really felt the significant uptick in the secondary trading volumes,” he said. “Bid wanted pressure has pressed clearing levels across the market. Active tax loss harvesting amongst cash bonds, as well as across products, particularly that we’re seeing in the ETF space, has really kind of magnified these moves.”
Furthermore, he explained, muni bonds have become much more attractive relative to U.S. Treasuries. The 30-year muni-to-Treasury ratio at 93% compared to 88% for the trailing one-year average. AA revenue bonds are offering a 4.15% tax-exempt yield in the 10-year space, and 5.15% at the long end, he explained. Those are levels not seen since “Liberation Day” last year.
“We have this setup that I would just say is like the trifecta of high absolute yields, cheap ratios and negative total returns,” he said. “While sometimes we dance around the idea of relative value, and by no means would I try to call a bottom, this setup typically bodes well for long-term income oriented buyers.”
The demand for liquidity is increasing yield premia, he added. While a record volume of muni bonds went out for the bid recently, less than approximately half actually traded, signaling that the market is trying to move faster than the available liquidity. That makes this a market with an appealing entry point for buyers with available capital, Gotelli explained.
Downside Risk in Muni Bonds: Gotelli’s Thoughts
As for the biggest downside risk in the space, he added, the risk of a negative feedback loop looms. That would entail a dynamic of negative returns causing outflows, which could cause further selling and further negative returns.
The lack of traditional reinvestment opportunities is typically experienced in June and December/January, he said. That makes that pressure more notable over the next few months. While it could offer buying opportunities, it may also cause volatility to remain elevated.
What does that mean for investors? Gotelli underscored a few notable areas of opportunity. In the next six to eight weeks, he said, he and his team are looking at incremental duration and parts of the curve that have not only normalized, but have become a lot cheaper, while generally “staying up in quality.”
“The high-grade market is giving you a lot of opportunity right now, just as a whole,” Gotelli said. “You don’t need to reach for yield in a market where ratios are this cheap and high-grade bonds are trading at discounts.”
See more: Get in Early: Tax Loss Harvesting Opportunities Are Spiking
American Century Investments offers multiple muni bond ETFs to consider. The firm operates the American Century Diversified Municipal Bond ETF (TAXF) and the American Century California Municipal Bond ETF (CATF) as examples. Reducing tax exposure and with buy opportunities, muni bonds could be a fixed income category to watch as yields shift.
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