The selloff in the municipal market has created an attractive entry point for investors, according to Alan Schankel, managing director at Janney Capital Markets.
At current levels, tax-free yields are as high as he’s seen since 2011, and investors should take advantage of recent volatility to add to their municipal position, he said in a research note Tuesday.
“Investors should use the 110 basis point bump in yields to selectively fill in rungs in a laddered municipal portfolio, our preferred strategy,” he wrote.
In recent weeks, municipal bonds have been attractively priced relative to Treasuries, with high-grade tax-free yields currently exceeding taxable Treasury yields, Schankel wrote. Municipal to Treasury ratios on longer maturities have been above 100%, finishing Monday at 109% in 10 year and 115% in 30 year maturities.
Schankel also points out that the differential between short maturities and longer maturities has steepened substantially, meaning investors are rewarded for extending maturity, particularly out to about 10 years.
Yields have steadily been increasing in past weeks, jumping Thursday after Federal Reserve chairman Ben Bernanke indicated that there may be an end in sight for the central bank’s bond buying program.
Monday, yields on the Municipal Market Data scale ended as much as 20 basis points higher. The 10-year and 30-year yields jumped 17 basis points each to 2.80% and 4.13%, respectively. The two-year yield increased 12 basis points to 0.55%.
Schankel said that while interest rates could increase further, the economic drivers to support that are not on the horizon.
“The low point for interest rates in this economic cycle is likely behind us, and volatility may continue, but we believe the tepid pace of economic growth and the moderate inflation outlook do not support significantly higher interest rates in the near term,” Schankel said.
Gross domestic product is growing in the 1.9% to 2.3% range, while inflation indicators continue to come in below 2%.
As to suggestions that a “Great Rotation” — the shift among investors out of fixed income and into equity — is upon us, Schankel says he sees no dramatic shift anytime soon, because changing demographics and retiring baby boomers are likely to buoy demand for fixed income investments.
