2023 Best Start for Municipal Bonds Since 2009

Investor confidence has grown as the Federal Reserve nears the end of its rate hike cycle. Faced with mounting evidence of a slowdown, investors are seizing higher bond yields before a potential recession, and the rate cuts that eventually follow, take them away. January has seen a flurry of cash inflows to bond funds, a sign of higher demand. High yields are a silver lining for those looking to buy municipal bonds. Not wanting to miss out on higher yields, while they last, many investors reckon it is time to buy bonds. January’s 2.8% index returns for municipal bonds is the biggest January return since 2009. The outperformance has pared losses seen last year. With policy rates poised to stabilize this year, 2023 is shaping to be the year to buy tax-free bonds.

Fed Urged to Avoid Promising More Rate Hikes

“I don’t think it’s a time to be committing to rate hikes, given the indications of softness that we have seen from a number of quarters,” former Treasury Secretary Lawrence Summers said, adding that the Fed needs to maintain maximum flexibility in an economy that could go either way. While the economy is in an uncertain state with inflation well above the Fed’s 2% target, there are signs of a slowdown. In December, Americans cut spending, and inflation cooled to its slowest pace since October 2021. The U.S. economy grew 1% in the fourth quarter of 2022 compared with a year earlier, down sharply from 5.7% growth in 2021. The slowdown reflects a return to a more normal pace of growth in 2022, following post- COVID-19 business re-openings and fiscal stimulus in 2021.

Window Closing on Easy Municipal Bond Returns

There has been a steady decline in tax-free yields since October. The drop in bond yields comes after last year’s worst municipal bond rout in four decades. Historically, positive returns have followed negative return years. Volatility is a constant theme in financial markets. Easy returns are very likely done, and “investors looking for more yield may need to go to the longer part of the curve, lower coupons or the A-rated and BBB-rated categories,” Bank of America strategists said, adding that while these decisions bear risk, “a combination of all three have produced the best returns over the past three months.”

Municipal Bond New Issues Down 19%

Demand for municipal bonds outweighs supply. State and local bond issuance has dipped to the slowest since 2018. January long-term municipal bond sales are down 19% from a year ago. High interest rates raise the cost of borrowing and diminish opportunities to refinance debt. Massive federal aid post-COVID-19 has boosted government cash coffers, with lesser need for new bond funds. The trend of low supply in the market has continued since 2022. With not enough new bond issuance to replace maturing bonds, the volume of outstanding state and local government bonds decreased in 2022.

Mark “Solomon” Bitton is a vice president, and veteran bond broker at the GMS Group. He has been advising municipal bond investors for over 25 years. He can be reached at 1-800-453-6233