Most of you who have been readers of Muni Nation know that I often mention the muni yield curve and use it as a reference and a point of comparison to other asset classes to identify, and make clear, opportunities.
In and of itself, the yield curve represents the estimation now of what is anticipated to be a fair return for a bond of the highest credit quality, issued to mature in each successive year, to a standard final maturity of 30 years. There is both a subjective as well as an objective component imbedded in the creation of these annual rates, expressed as the yield curve. But, most importantly, the yield curve is used as a benchmark from which the value (spread) of other bonds of similar maturity, but different credit quality, is derived.
Interestingly, taken alone, the yield curve itself can change as the outlook for the economy morphs or, for example, when the Federal Reserve (Fed) forcibly adjusts the federal funds rate.
So, why this short academic exercise?
December 2015 was the last time the Fed raised rates, and in a Muni Nation post from last December, I discussed what we anticipate to happen in a rising rate scenario. Since that post, it is useful to note, as demonstrated by the graph below, that indeed the municipal bond curve has flattened between 1 and 30 years some 39 basis points despite no further Fed rate increases. The anticipatory nature of this change has helped to generate total returns of the Barclays Long Municipal Bond Index of 4.24% compared to the Barclays Municipal Bond Index of 2.80% year-to-date through May 20, predominantly due to the strength of demand for long bonds.
The municipal yield curve structure is itself a proxy for the overall market, reflecting changes in supply and demand as well as influences of economic activity and Fed policy. The curve has flattened and returns are positive. The only question is: What do the remaining 7 months hold in store for our muni portfolios? Much of this may depend on whether the Fed takes any rate action or not. Either way, we will be sure to revisit this at year end.
Muni Yield Curve Flattening January - May 2016 Helped Generate Positive Returns for Munis
Post Specific Disclosures
Yield to Worst measures the lowest of either yield-to-maturity or yield-to-call date on every possible call date.
The Barclays Long Municipal Bond Index is considered representative of the broad market for investment grade, tax-exempt bonds with a maturity of at least 22 years or more. The Barclays Municipal Bond Index is considered representative of the broad market for investment grade, tax-exempt bonds with a maturity of at least one year.
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