Can Muni Bonds Keep Outperforming?

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Can Muni Bonds Keep Outperforming? by James Dearborn,

Thanks to strong technicals, the municipal market is having a great year. If the economy and interest rates end the year near today’s levels, we expect the positive trends to continue.

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2016 is proving that technical factors matter for munis. While Puerto Rico’s debt crisis has made the headlines, the bigger story is that overall credit conditions in the municipal market have stabilized. Instead of defaults, we are seeing positive rating actions — more upgrades than downgrades in our market. Also, U.S. Treasury yields have fallen during the first part of this year, driving yields lower and prices higher on municipal bonds. Lastly, in a world of low or even negative interest rates, foreign investors have shown up in our market like never before — this is contributing to strong demand for munis, but there’s not a lot of supply.

It’s hard to tell whether the muni market is fairly valued. A lot depends on what Treasury rates do, and a lot of that depends on what happens with the global and U.S. economies. If Treasury rates continue to fall, we could still see more price appreciation. But remember that we are at historically low levels of yields on 10-year Treasuries, 30-year Treasuries and municipal bonds. So we are not predicting that rates are going to fall very much from here. Assuming the economic environment at year end is close to where it is today, we expect the coupon on your muni bonds to be in line with your return.

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