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Woe Is Munis? - Friday, 10/25/2013

I cannot help but feel that fixed income investors may currently be finding themselves in a hope-and-despair loop, reeling most recently from political brinkmanship over what may occur in January 2014: another round of brinkmanship and ultimately, the looming possibility of Federal Reserve tapering and higher interest rates.

After the delayed release of the September employment numbers, Barclays (amongst others banks) began to trumpet its expectations that Fed tapering would hold off until at least March 2014. The slowness in jobs creation appears to have given the bond markets a reprieve, at least temporarily, and if the outlook doesn't change, I believe investors have perhaps five months before the next significant decision point arrives.



Change in U.S. Non-Farm Employment Image 

Source: FactSet, as of October 22, 2013.

Meanwhile, it appears that municipal bond investors are continuing to distance themselves from the tax-exempt market in a fashion that, in my opinion, has created some market dislocations and potential opportunities. The discussion of Puerto Rico bonds aside, many observers of the market have noted that the municipal bond curve remains steep, which may benefit those who can tolerate interest rate risk for the higher yields available further out on the yield curve. I believe one such opportunity resides in the intermediate range of the yield curve, where steepness may offer a chance to capture a measure of return going into the year-end yield roll down1.

Municipal high yield, in my opinion, is another area of opportunity. Currently, the spread differential between the Barclays Municipal High Yield Index and the Barclays (investment-grade) Municipal Bond Index2 is nearly 75 basis points3. This spread is above the long-term average and represents a potential opportunity that I believe is worthy of notice during these very uncertain times.

1Roll down refers to the price appreciation a bond experiences as it "rolls down" the curve toward maturity and approaches the steepest part of the curve where market demands lower yields. As a result, a bond paying a coupon greater than what the market is currently pricing in will see its price increase.

2The 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. The Barclays Municipal High Yield Index is considered representative of the broad market for below investment-grade, tax-exempt bonds with a maturity of at least one year.

3Source: Bloomberg, as of October 22, 2013.


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