Munis are hot right now: And there's plenty to go around
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Here's a surprising combination of words: Municipal bonds are sexy right now — offering historically attractive returns at a time when states and localities need more and more cash.
Why it matters: That may be good news for investors, but it costs taxpayers who foot the bill when states and localities borrow money by issuing these bonds.
Where it stands: A sell-off in municipal bonds in September, when interest rates began to rise, was the worst since the financial crisis. Now, yields, which move inversely to prices, are at historic highs.
- State and local governments have issued $611.8 billion in munis over the 52-week period ending Oct. 16, according to Bloomberg data compiled by muni analyst Matt Fabian, president of Municipal Market Analytics.
- It's a record high.
How it works: Municipal bonds are used by states and localities to fund infrastructure — building your roads, bridges, schools and whatnot.
- They've long been appealing to investors because of the tax breaks. Nearly half of outstanding muni bonds are held directly by households or nonprofits, per Federal Reserve data as of the second quarter.
- The income from munis is exempt from federal taxes — and some states offer a state tax exemption, too.
- So Wall Street calculates a "tax-equivalent yield," for those in high tax brackets — a measure of how much a taxable bond would have to yield to deliver the same return as a tax-exempt muni.
By the numbers: As of Sept. 30, the tax-equivalent yield on municipal bonds was at 8.07% for investors in the highest federal tax bracket, according to a new BlackRock report. For high-yield munis, the number was 10.48%.
- The underlying yield on the broader muni bond index was the highest since the 2008 financial crisis, per the report.
Yes, but: Those eye-popping numbers have fallen back a bit as Treasury yields have fallen off recent highs this week.
Catch up quick: In the wake of the financial crisis, states pared back borrowing as they sought to rein in costs and deal with pension funding shortfalls. Then came the pandemic, and the federal government showered local governments with money.
State of play: Now the federal money is gone, and cuts are happening, so states are dealing with a lot of crumbling long-neglected infrastructure and less support. There's a big backlog of infrastructure projects to get done.
- Plus, inflation is making everything more expensive to build — leading to even more issuance.
- "The trucks that dig up the road now cost 50% more to run because of fuel expense, and the asphalt costs twice as much, etc.," Fabian, the muni analyst, says. Many of the bonds issued this year are so-called "completion bonds," for existing projects.
- On top of that, there's climate change: "It wears down existing infrastructure faster, and it raises the cost of replacing it because you need better or at least different stuff."
The intrigue: You might think that the surging interest rates would slow bond issuance down. But it dipped only for a bit, and now governments are back at it, Fabian says.
- He projects issuance to accelerate over the next decade to as much as $1 trillion a year.
What they're saying: Wall Street is amped about munis, touting the rise in yields as an "opportunity" — that's the word du jour. It's a chance to lock in "historically attractive income" for investors, regardless of where rates go next, Pat Haskell, head of the municipal bond group at BlackRock, noted.
- JPMorgan also highlighted the "rare opportunity" at play in munis in a note earlier this week.
"Wait a minute. Munis?!" exclaimed Goldman Sachs' Chris Hussey on a recent podcast, after being told of the high yields.
- "Can you believe it?" responded Alex Finston, co-head of U.S. and Asia credit trading at the bank.
- "I haven't heard a municipal bond get pitched in a long time," Hussey said.
