2 Views Of Interest Rates

David Kotok profile picture
David Kotok
2.11K Followers

Summary

  • Muni debt is mostly owned by tax-paying Americans, and their preferences determine the market prices of the debt.
  • Trillions in derivatives are tied to Treasury debt structures and are part of global transactions that ignore the yield curve outlook and trade against the Treasury yield curve.
  • In our opinion, Short-term rates are heading higher.

Small box in a newspaper containing interest rates info

alicat

By David R. Kotok

If you look at the US Treasury yield curve, you see an inversion; hence your conclusion may be a recession and lower future interest rates. See green line below.

US Treasury Actives Curve

If you look at the matching AAA muni yield curve (blue line), you see a steep upward sloping curve; hence you may conclude that there is no recession and interest rates are headed higher.

Which conclusion is correct? Why are they so different when both represent highest-credit-quality, US-dollar-denominated debt issued by sovereign governments with near-zero default risk, and the major difference is that munis are tax-free while Treasury debt is taxable for Americans?

Muni debt is mostly owned by tax-paying Americans, and their preferences determine the market prices of the debt in the blue curve. Treasury debt is owned mostly by foreigners or American institutions whose preferences are determined by legal restrictions or preferred-habitat investment decisions. Trillions in derivatives are tied to Treasury debt structures and are part of global transactions that ignore the yield curve outlook and trade against the Treasury yield curve. Munis don’t have that characteristic.

So maybe the muni curve is telling us a better story about future interest rates. We will find out. Note how yields are about the same for the longest maturity.

In our opinion, Short-term rates are heading higher. We’re scaling back duration. We would buy the tax-free muni at 4% plus. We won’t buy the 30-year Treasury.

As the saying goes, “You pays your money, and you takes your choice.” If we won’t buy a 30-year Treasury bond for ourselves, we certainly cannot in good conscience buy it for our clients.

Original Post

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

This article was written by

David Kotok profile picture
2.11K Followers
David Kotok co-founded Cumberland Advisors in 1973 and has been its Chief Investment Officer since inception. David’s articles and financial market commentaries have appeared in The New York Times, The Wall Street Journal, Barron’s, and other publications. He is a frequent contributor to Bloomberg TV and Bloomberg Radio, Yahoo Finance TV, and other media. He has authored or co-authored four books, including the second edition of From Bear to Bull with ETFs and Adventures in Muniland. He holds a B.S. in economics from The Wharton School of the University of Pennsylvania, an M.S. in organizational dynamics from The School of Arts and Sciences at the University of Pennsylvania, and an M.A. in philosophy from the University of Pennsylvania.David has served as Program Chairman and currently serves as a Director of the Global Interdependence Center (GIC), www.interdependence.org, whose mission is to encourage the expansion of global dialogue and free trade in order to improve cooperation and understanding among nation states, with the goal of reducing international conflicts and improving worldwide living standards. David chaired its Central Banking Series and organized a five-continent dialogue held in Cape Town, Hong Kong, Hanoi, Milan, Paris, Philadelphia, Prague, Rome, Santiago, Shanghai, Singapore, Tallinn, and Zambia (Livingstone). He has received the Global Citizen Award from GIC for his efforts. David is a member of the National Business Economics Issues Council (NBEIC), the National Association for Business Economics (NABE), has served on the Research Advisory Board of BCA Research and is currently on the advisory board of RiskBridge Advisors. He has also served as a Commissioner of the Delaware River Port Authority (DRPA) and on the Treasury Transition Teams for New Jersey Governors Kean and Whitman. Additionally, he has served as a board member of the New Jersey Economic Development Authority and as Chairman of the New Jersey Casino Reinvestment Development Authority.

Recommended For You

Comments (2)

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.