The Case for Long-Term Munis: Positioning for Rate Cuts
September 13, 2024
Read Time 5 MIN
The Case for Long-Term Munis: Positioning for Rate Cuts
The Federal Funds rate has held steady at 5.33% for over a year, but the Federal Reserve (Fed) is now signaling that this period may be coming to an end. With potential rate cuts on the horizon in September, long-term municipal bonds are becoming more attractive. This blog will explore why now could be the ideal time to consider reallocating into long-term munis.
- Fed Rate Cycles and Long-Term Munis
- The Case for Long-Term Munis
- Superior Credit Quality
- Strong Historical Performance
- Competitive Yields and Tax Benefits
- Strong Municipal Bond Issuance
Understanding the Fed Rate Cycles and Long-Term Munis
Historically, long-term bonds, including munis, tend to benefit when the Fed shifts from hawkish to dovish, and historical data shows strong returns after these shifts. This potential makes long-term munis attractive as these longer bonds offer higher income and potential total returns.
The Case for Long-Term Munis
Long-term municipal bonds are emerging as a strong alternative to Treasuries. Municipal bonds are exempt from federal taxes and, in some cases, exempt from state and local taxes. They typically offer solid credit quality and can provide a higher tax-equivalent yield compared to taxable bonds. The longer the duration, the larger the potential for price appreciation during periods of interest rate cuts. For example, the ICE Long AMT-Free Broad National Municipal Index (MBNL), which tracks 'long munis,' has a modified duration to worst of 13 years. This means that if interest rates dropped by 1%, the index’s price could potentially rise by approximately 13%. The current modified duration to worst of long munis is still near the longest it’s been in the last ten years, meaning these bonds are more sensitive to interest rate changes than usual.
Current Era of Duration is the Longest in a Decade
Source: ICE. As of 8/31/2024. Past performance is no guarantee of future results. Modified Duration measures a bond’s sensitivity to interest rate changes that reflect the change in a bond’s price given a change in yield. Please see index definitions disclosures at the bottom of the page. Index performance is not illustrative of fund performance. It is not possible to invest directly in an index.
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Superior Credit Quality
Long-term munis credit quality is better compared to a decade ago. Improved credit rating processes and the enhanced financial health of issuers have led to lower default rates for municipal bonds relative to corporate bonds. Ratings illustrate this strength in quality. According to ICE, the average credit rating for municipal bonds has steadily improved over the past decade, rising from 760 to 780. Meanwhile, the average credit rating for U.S. Treasuries dropped from 864 to 816 after Fitch downgraded them to AA+. Muni credit ratings have become a comparable alternative to those of U.S. Treasuries.
Munis and Treasuries Have Similar Credit Quality
Source: ICE. As of 8/31/2024. Past performance is no guarantee of future results. The ICE Average Credit Rating is a composite rating calculating using simple averages of ratings from Moody’s, S&P and Fitch. The composite rating is calculated by assigning a numeric equivalent to the ratings in each agency’s scale. See index definitions and disclosures at the bottom of the page. Index performance is not illustrative of fund performance. It is not possible to invest directly in an index.
Strong Historical Performance
Long-term munis have demonstrated resilience during market transitions and are well-positioned to bounce back as rate cuts potentially begin. Their market position is expected to strengthen further.
Long-Term Munis Outperformance During Rate Cuts
Source: ICE. As of 8/31/2024. Past performance is no guarantee of future results. See index definitions disclosures at the bottom of the page. Index performance is not illustrative of fund performance. It is not possible to invest directly in an index.
MLN | VanEck Long Muni ETF
Competitive Yields and Tax Advantages
Long-term munis offer competitive yields when compared to other fixed-income assets. Proposed changes in top marginal tax rates could increase demand for tax-exempt munis, especially with the potential sunsetting of the Tax Cuts and Jobs Act (TCJA) in 2025. This would bring back a top marginal rate of 39.6%. The election could have a significant impact on munis, depending on how the future administration handles the top marginal tax rate. Former President Trump has previously suggested extending the TCJA, while Vice President Harris will likely let the TJCA expire.
Long-Term Munis Top Other Bond Categories in Yield to Worst
Source: ICE. As of 8/26/2024. Yield to Worst (YTW) is a measure of the lowest possible yield that can be received on a bond that fully operates within the terms of its contract without defaulting. See index definitions disclosures at the bottom of the page. Index performance is not illustrative of fund performance. It is not possible to invest directly in an index.
Strong Municipal Bond Issuance
Lastly, the supply of municipal bonds has gotten off to a big start this year. Even with the possibility of lower rates in the future, issuers have issued more new debt than ever in the last decade. Issuers may be getting ahead of the U.S. election. The increased issuance earlier this year presents a unique buying opportunity due to the higher supply, often leading to better prices for investors.
Muni Issuance this Year (Through July) is the Highest in a Decade
Source: Bloomberg . As of July 31, 2024.
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IMPORTANT DISCLOSURES
Source: Moody’s Investors Service: US municipal bond defaults and recoveries, 1970-2022.
Index Definitions
Long Munis - ICE Long AMT-Free Broad National Municipal Index (MBNL) tracks the performance of long-maturity U.S. dollar-denominated investment grade tax-exempt debt publicly issued in the U.S. domestic market by U.S. states and territories as well as their political subdivisions.
AAA Munis - ICE BofA AAA Municipal Securities Index (U0A1) is a subset of ICE BofA US Municipal Securities Index including all securities rated AAA. ICE BofA US Municipal Securities Index (U0A0) tracks the performance of U.S. dollar denominated investment grade tax-exempt debt publicly issued by US states and territories, and their political subdivisions, in the US domestic market.
Broad Munis - ICE US Broad Municipal Index (MUNI) tracks the performance of U.S. dollar denominated investment grade tax-exempt debt publicly issued by US states and territories, and their political subdivisions, in the US domestic market.
US Treasuries - ICE BofA US Treasury Index (G0Q0) tracks the performance of U.S. dollar denominated sovereign debt publicly issued by the US government in its domestic market.
Corporates - ICE BofA US Corporate Index (C0A0) tracks the performance of U.S. dollar denominated investment grade corporate debt publicly issued and settled in the US domestic market.
US Broad FI - ICE BofA US Broad Market Index (US00) tracks the performance of U.S. dollar denominated investment grade debt publicly issued and settled in the US domestic market, including US Treasury, quasi-government, corporate, securitized and collateralized securities.
Definitions
Yield to Worst - Measures the lowest of either yield-to-maturity or yield-to-call date on every possible call date.
Duration to Worst - Measure of the duration of a bond computed using the bond's nearest call date or maturity, whichever comes first. This measure ignores future cash flow fluctuations due to embedded optionality.
This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities, financial instruments or digital assets mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, tax advice, or any call to action. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results, are for illustrative purposes only, are valid as of the date of this communication, and are subject to change without notice. Actual future performance of any assets or industries mentioned are unknown. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. VanEck does not guarantee the accuracy of third party data. The information herein represents the opinion of the author(s), but not necessarily those of VanEck or its other employees.
Municipal bonds may be less liquid than taxable bonds. A portion of the dividends you receive may be subject to the federal alternative minimum tax (AMT). There is no guarantee that municipal bonds’ income will be exempt from federal, state or local income taxes, and changes in those tax rates or in alternative minimum tax rates or in the tax treatment of municipal bonds may make them less attractive as investments and cause them to lose value. Capital gains, if any, are subject to capital gains tax. When interest rates rise, bond prices fall.
An investment in the VanEck Long Muni ETF (MLN) may be subject to risks which include, among others, municipal securities, credit, interest rate, California, New York, Texas, call, health care bond, special tax bond, market, operational, sampling, index tracking, tax, authorized participant concentration, no guarantee of active trading market, trading issues, passive management, fund shares trading, premium/discount and liquidity of fund shares, and index-related concentration risks, all of which may adversely affect the Fund. Municipal bonds may be less liquid than taxable bonds. There is no guarantee that the Fund's income will be exempt from federal, state or local income taxes, and changes in those tax rates or in alternative minimum tax rates or in the tax treatment of municipal bonds may make them less attractive as investments and cause them to lose value. Capital gains, if any, are subject to capital gains tax. The Fund's assets may be concentrated in a particular sector and may be subject to more risk than investments in a diverse group of sectors.
Investing involves substantial risk and high volatility, including possible loss of principal. An investor should consider the investment objective, risks, charges and expenses of a Fund carefully before investing. To obtain a prospectus and summary prospectus, which contain this and other information, call 800.826.2333 or visit vaneck.com. Please read the prospectus and summary prospectus carefully before investing.
© Van Eck Securities Corporation, Distributor, a wholly-owned subsidiary of Van Eck Associates Corporation.
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IMPORTANT DISCLOSURES
Source: Moody’s Investors Service: US municipal bond defaults and recoveries, 1970-2022.
Index Definitions
Long Munis - ICE Long AMT-Free Broad National Municipal Index (MBNL) tracks the performance of long-maturity U.S. dollar-denominated investment grade tax-exempt debt publicly issued in the U.S. domestic market by U.S. states and territories as well as their political subdivisions.
AAA Munis - ICE BofA AAA Municipal Securities Index (U0A1) is a subset of ICE BofA US Municipal Securities Index including all securities rated AAA. ICE BofA US Municipal Securities Index (U0A0) tracks the performance of U.S. dollar denominated investment grade tax-exempt debt publicly issued by US states and territories, and their political subdivisions, in the US domestic market.
Broad Munis - ICE US Broad Municipal Index (MUNI) tracks the performance of U.S. dollar denominated investment grade tax-exempt debt publicly issued by US states and territories, and their political subdivisions, in the US domestic market.
US Treasuries - ICE BofA US Treasury Index (G0Q0) tracks the performance of U.S. dollar denominated sovereign debt publicly issued by the US government in its domestic market.
Corporates - ICE BofA US Corporate Index (C0A0) tracks the performance of U.S. dollar denominated investment grade corporate debt publicly issued and settled in the US domestic market.
US Broad FI - ICE BofA US Broad Market Index (US00) tracks the performance of U.S. dollar denominated investment grade debt publicly issued and settled in the US domestic market, including US Treasury, quasi-government, corporate, securitized and collateralized securities.
Definitions
Yield to Worst - Measures the lowest of either yield-to-maturity or yield-to-call date on every possible call date.
Duration to Worst - Measure of the duration of a bond computed using the bond's nearest call date or maturity, whichever comes first. This measure ignores future cash flow fluctuations due to embedded optionality.
This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities, financial instruments or digital assets mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, tax advice, or any call to action. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results, are for illustrative purposes only, are valid as of the date of this communication, and are subject to change without notice. Actual future performance of any assets or industries mentioned are unknown. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. VanEck does not guarantee the accuracy of third party data. The information herein represents the opinion of the author(s), but not necessarily those of VanEck or its other employees.
Municipal bonds may be less liquid than taxable bonds. A portion of the dividends you receive may be subject to the federal alternative minimum tax (AMT). There is no guarantee that municipal bonds’ income will be exempt from federal, state or local income taxes, and changes in those tax rates or in alternative minimum tax rates or in the tax treatment of municipal bonds may make them less attractive as investments and cause them to lose value. Capital gains, if any, are subject to capital gains tax. When interest rates rise, bond prices fall.
An investment in the VanEck Long Muni ETF (MLN) may be subject to risks which include, among others, municipal securities, credit, interest rate, California, New York, Texas, call, health care bond, special tax bond, market, operational, sampling, index tracking, tax, authorized participant concentration, no guarantee of active trading market, trading issues, passive management, fund shares trading, premium/discount and liquidity of fund shares, and index-related concentration risks, all of which may adversely affect the Fund. Municipal bonds may be less liquid than taxable bonds. There is no guarantee that the Fund's income will be exempt from federal, state or local income taxes, and changes in those tax rates or in alternative minimum tax rates or in the tax treatment of municipal bonds may make them less attractive as investments and cause them to lose value. Capital gains, if any, are subject to capital gains tax. The Fund's assets may be concentrated in a particular sector and may be subject to more risk than investments in a diverse group of sectors.
Investing involves substantial risk and high volatility, including possible loss of principal. An investor should consider the investment objective, risks, charges and expenses of a Fund carefully before investing. To obtain a prospectus and summary prospectus, which contain this and other information, call 800.826.2333 or visit vaneck.com. Please read the prospectus and summary prospectus carefully before investing.
© Van Eck Securities Corporation, Distributor, a wholly-owned subsidiary of Van Eck Associates Corporation.