As investors prepare for the possibility that interest rates will remain high for an extended period of time, one investment category is actually benefiting from the high-interest rate environment. Dan Close, head of municipal bonds at Nuveen, spoke on Catalysts about the merits of investing in municipal bonds as the Federal Reserve considers possible future rate cuts.
Close points out two big themes happening right now: First, the 10-year Treasury yield (^TNX) is up 50 basis points, which Close explains is affecting all fixed income securities, which are now 50 basis points cheaper than they were at the start of the year.
The second theme boils down to supply: Close notes that municipal bond supply is on the rise, with more than $40 billion in supply in April and May. He believes this will lead to a decline in issuance as elections approach later this year.
“I think the next couple of months will be a very good technical situation with coupons, maturing bonds and a variety of revenues flowing back into the muni market very quickly, both of which are very good technical backstops,” Close told Yahoo Finance.
To learn more about expert insights and the latest market trends, click here to watch this full episode of Catalysts.
This post was written by Melanie Leal
Video Transcript
Inflation and a strong job market have rattled markets over the past few months, and investors are bracing for interest rates to remain high for even longer.
But one investment vehicle is seeing some benefit from the high interest rate environment, and that’s municipal bonds, and we have a new head of municipal bonds joining us right now, so thank you so much for joining us.
There is now hope that the Fed may start cutting interest rates later this year.
With that in mind, now is the right time to put some money into municipal bonds.
of course.
And Ali, thank you so much for inviting me.
Thank you very much.
Yes, I certainly think so.
So, when you look at what’s happened at Muni so far this year, there have been two big themes.
First, the 10-year Treasury interest rate rose by 50 basis points.
So all bonds, including municipal bonds, are affected, and are now 50 basis points cheaper than they were at the start of the year.
Well, the second factor that’s really impacting Muni, and why we think Muni is so valuable right now, is Muni supply.
By the end of May, municipal bond supply had increased by 40%.
And in April and May, supply exceeded $40 billion for two consecutive months.
I think this sets us up very well for the second half of the year.
I don’t think there will be a large amount issued.
We are being contacted by underwriters.
We are hearing from issuing bankers that they are bringing forward deals that would normally be made in the fourth quarter to avoid the election and all the issues that would come with the 2016 election.
So I think we’ll see a decline in issuance, and I think we’ll be in a very good place over the next couple of months with $80 billion in maturing coupons and a lot of revenue flowing back into the muni market very quickly.
These are both very good technical backstops.
And as we discussed earlier, I think the 6.25% on the AA Medium Term Muni Strategy is very attractive, and the high yield of 9.25% is enough to attract investors.
Yeah, I mean, those are pretty decent yields, especially when you’re talking about things like Treasury bonds and corporate bonds.
The returns are not that high.
I’m curious about the risk of those returns.
How closely should you and/or municipal bond holders be monitoring macro data and potential weaknesses in that data, and how might that impact municipal bonds?
Yes, of course.
Naveen has 23 credit analysts, but all they do is look at the broader macroeconomics, and when you take a step back, you don’t typically see a high correlation between the economy and municipal defaults.
This means, as you know, that it is not possible to not pay your water or sewerage bills, regardless of your financial situation.
Most of these have highly inelastic demand curves.
These are essential services, monopolies, and somewhat recession-proof, just about everything we see, but we don’t see a huge correlation between Muni’s defaults and where the defaults are and the state of the economy.
yes.
And, you know, Muniz’s support base is very fragmented.
What sector or area are you most bullish on right now?
yes.
There are over 50,000 different publishers in the town I live in, and I live just north of Chicago.
There are nine publishers in that town alone.
So it’s a very fragmented market.
It’s on the luxury side.
We are seriously considering local general obligation bonds.
These are bonds that are paid off through property taxes.
We believe the housing market continues to perform well and offers very good yields.
On the high yield side, we particularly like land and secure deals.
These are transactions in which funds are raised for drinking water or streetscape improvements in states such as Florida, and are ultimately paid back through property taxes and various assessments.
So we have high hopes for these two.
We believe these cities will do very well over the next few years, recession or not.On an issue a little closer to home to New York City, I want to bring up Governor Kathy Hall’s move to repeal congestion pricing policies and now some are calling on MT A municipal bondholders to fight back against that move.
I would like to retract a post made by the president of a public works focused non-profit calling on everyone who has purchased MT A municipal bonds to come forward and harm New York State.
Don’t ask about congestion pricing.
I won’t get into that exchange here, but I’m just generally curious about how much power large groups of bondholders have historically had over public policy.
And is this a way for investors, individual investors who are investing in local politics who are listening to this segment right now, to have another avenue of influence, although “influence” is not the word I’m after?
Yeah.
Well, the interesting thing is that congestion pricing would have been very beneficial for minibonds.
Going in, we get the $1 billion in revenue that we were expecting.
It can leverage itself by issuing debt up to $15 billion.
That really helps with capital structure.
You see, if congestion pricing meant fewer cars on the road, I would support a fairback bond.
You know, we hold mini bonds.
Unlike on the equity side, where you can vote for directors and vote on various governance issues, you can’t do that.
We don’t have as many as the big MT A holders.
We certainly have influence, but it’s something that has traditionally been overused by asset managers, at least in the municipal bond space.
Naveen has a century and a quarter of a century of history in providing tax-free income.
Part of the reason is because we know that sometimes local issues and local conditions don’t have much impact.
Now, just briefly, you mentioned some of your thoughts on airports, university bonds, and obviously the huge demand for travel that’s coming up this summer.
How does this affect airport bonds?
So airport bonds have done very well.
this year.
Well, the number in circulation is about 3.5 billion.
So Midway SFO issued.
Well, we’ve seen issuance come to fruition, and we expect issuance in the region of $20 billion for the remainder of the year.
So I think it was interesting.
Airport credit is doing really well.
Consider an airport that has lost 80% of its total revenue, yet has seen an increase in upgrades and downgrades, with 25% of them now rated higher than they were before the pandemic.
So airports are expected to see more ticketing, but much of that will come not from runways and gates, but from passenger experience lounges, rest areas, restaurants and shopping.
So it’s not a traditional brick-and-mortar store, it’s more of an experience that we’re funding.
As a result, we expect to see more airport bond issuance over the remainder of the year, reaching $20 billion in 2024 and $100 billion and $50 billion by the end of 2027.
That’s really interesting, Dan. I always enjoy talking with you because you have the ability to make muni bonds a reality for people.
Thank you very much.
Thank you for coming to our studio.
Thank you so much for inviting me.
Yep, that’s Dan Close.
He is the Naveen Municipal Commissioner.
