Fixed Income

Yields rose across all fixed income assets due to expectations of swift Federal Reserve (Fed) rate hikes to curb run-away inflation, and munis were no exception. The “rich” valuations that we pointed out last quarter have turned firmly into our “cheap” range as a result of the selloff.

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Record fund inflows led to unprecedented demand for Munis last year, keeping volatility at a minimum compared to the wild swings in the Treasury market. As inflows are expected to continue and supply remains light to start the year, we expect modest outperformance in the near term.

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As the economy reopens, we believe growth is set to surge. The United States is well along the path on vaccination, which is unleashing months of pent-up demand. Meanwhile, other parts of the world are lagging in vaccinations and confronted with potential challenges, including a stronger dollar. Given continued signs of progress and growth in the United States, we refocus tactically around domestic and high-quality assets. We also maintain a tactical overweight to equity over bonds, given incoming data as we enter the third quarter.

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Is there a way for bond investors to win if interest rates rise? We think laddering bonds is one way to navigate an uncertain and changing environment. First, we must start with a simple fact. Nobody knows for sure what will happen to interest rates in the future. There are potential ranges of plausible outcomes, but in reality, the future direction of interest rates is unknowable. What is knowable is today’s level of interest rates. So, an investor interested in knowing the nominal dollar return of a T-bill or zero-coupon U.S. Treasury can know that future return with certainty today….

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After remaining relatively flat for the first six weeks of the year, Muni yields took a sharp turn higher in mid-February, finally beginning to catch up to the rise in U.S. Treasury yields. Improving economic growth numbers combined with the proposed $1.9 trillion Federal Stimulus Bill have resulted in continued expectations of increasing inflation leading to higher yields. Inflows into Muni Mutual Funds continued for the month but at a much slower pace and we expect lower inflows or even an outflow cycle over the coming weeks, resulting in reduced demand. Our defensive approach has held up through this selloff…

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To The Bone

Interest rates on bonds are at very low levels. The decline in the United States rates follows those of other sovereigns like Germany, the United Kingdom, and Japan (Chart A, below). In turn, global rates are following a long-established, declining secular trend. That trend leads to “negative” rates with more than $17 trillion in such debt circulating globally (Chart B, below). The defeating of inflation and worries of deflation may be behind this trend. Still, other factors may also be at work. Chart A U.S. Long-Term Treasury Yields vs. Average Foreign Yield (Germany, United Kingdom, Japan) Chart B Aggregate Global…

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In October, Muni yields crept higher, rising by 6-9 bps across the curve, echoing the move higher in US Treasury yields. Muni Mutual funds recovered from a single week of outflows and took in over $5 billion for the month. After the election results were announced, how-ever, both Muni and U.S. Treasury yields fell dramatically as expected gridlock in the split legislature diminished the prospects of a massive stimulus package and higher inflation. The main story in Munis was record monthly supply in October as issuers rushed to market prior to the election.

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