Do Rates Drive Muni Performance?

While the municipal bond market generally follows rate changes in the U.S. Treasury market, it does not move in lockstep, which is why sometimes we see muni-treasury ratios upwards of 80% to low 90%. This is because the typically low volatility of munis is directly related to the fact that only approximately 2% of all outstanding bonds trade in a given day, making it challenging to reprice all of the bonds that do not trade.

The chart below shows that even over a long history of Fed rate policy changes across a variety of market cycles, municipal bonds have consistently delivered positive returns. A contributing factor is that the tax exemption is valuable in all rate and tax environments to many types of investors. The chart depicts that looking back over the last 26 years, munis have delivered negative returns during only four of those years. Throughout those periods, both rates and credit concerns were working together to drive down all fixed income, unlike the current situation.

Yearly Muni Index Returns and Changes in Fed Funds Rate

Source: Morningstar and FRED. As of 3/17/2022. Past performance is no guarantee of future results.

The prevailing coupon of most municipal issues is 5%, and since total return includes both price movements as well as income, greater price declines than we have seen recently would need to continue through the balance of the year, which we feel is unlikely. We believe it is likely that 2022 will also deliver modestly positive performance by year-end.

Disclosures

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