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Posts Tagged ‘historically low spreads’

The Right Bond

January 31st, 2024 by Kurt L. Smith

We began 2024 with municipal bonds having rallied, not just in price, but also relative to U.S. Treasury yields. Ten-year generic AAA municipal yields were 3.62% on October 23rd and 2.35% on December 23rd (all prices and yields per Bloomberg). Compared to treasury yields, the 2.35% on municipals was 62% of the 3.78% on treasuries.

Municipal bonds are spread product. Investors like us buy them because the bonds offer a spread (better yield) to the so-called risk free U.S. Treasury bonds of a similar maturity. At 62%, municipal bonds offer some of the smallest spreads in decades yet investors continue to buy. Bloomberg’s Joe Mysak noted this last week, saying “if munis revert to their long-term valuations, or around 85% of treasuries, they should yield more than 3.50% right now…there’s still a long way to go.” Yields have bumped up slightly. Look at this month’s new issue highlight: the Wiley Independent School District in Abilene, TX bonds below. But as Mysak says, they still have a ways to go.

Yields on municipals continue to be much higher than those we saw in 2020, 2021 or 2022, though on a relative basis they are quite expensive. Tens of billions of dollars of new issue long-term municipal bonds were priced in January. They do not need our help getting them sold. Municipalities never need our help, whether interest rates are low and going lower or high and going higher.

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Still Zig Zagging Away

June 3rd, 2023 by Kurt L. Smith

According to Bloomberg’s Nic Querolo, municipal bonds lost 1.38% for the month through late May, which would make it the worst May performance since 1986’s 1.63% loss. Querolo goes on to say May has been the strongest month for municipal performance over the past ten years at up .9% on average.

While I place the beginning of the bond bear market in March 2020, municipal bonds did not peak until August 4, 2021, per Bloomberg, selling off into the first leg of the bear market October 26, 2022 with a 13.4% decline in the Bloomberg Municipal Bond Total Return Index.

The correction since late September/early October has occurred for many, if not all, asset classes, municipals included. It was the correction’s peak in April that set up municipal bonds dreadful May.

We are still in correction territory and unfortunately (for traders), that is a tough place to be. February was a dreadful month for municipals as well but the bond market’s response to the bank failures in early March sent prices to new correction highs (new yield lows). Will we see another move to new correction price highs or is a tough May the precursor of higher yields yet to come?

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Not Matching Expectations

December 20th, 2022 by Kurt L. Smith

In the hustle and bustle of the season, we would expect no less in a bull, bull, bull world. Our experience matches our expectations. Such is not the case with the financial markets.

While we are a couple weeks away from posting final 2022 results, the bull, bull, bull world has failed to deliver results. Depending on your yardstick of choice, you might categorize the results as poor, bad, or even horrific. Yet we cannot blame investors for not trying: the rally in both stocks and bonds from October to early December appeared to have legs…until it did not.

There is a reason for this expectation/performance mismatch, and it is not inflation. The reason is the bull market is over. And while stock investors may continue to believe they have seen this movie before, bond investors are surprisingly acting the same way.

Nowhere is the bull, bull, bull world more apparent than in the world of bonds. One example is in spreads. In writing about the treasury market, Jeff Sommer at the New York Times says “this has been an awful year for U.S. bonds — so bad that 2022 may end up as the worst calendar year in history.” Maybe that explains how Idaho Housing sold its 4.384% taxable municipal at 11 basis points below treasury yields (higher priced) last week (per Bloomberg). The bond is not a treasury! Idaho Housing bonds due six months later sold to the spread of seven basis points. Yeehaw! A lack of spread to treasuries is very bull, bull, bull.

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Bonds (Don’t) Move

January 20th, 2021 by Kurt L. Smith

Everyone can agree bond yields are low. Another way of saying that is, everyone can agree bond prices are high. But unlike the unhinged high prices of stocks, bonds are tethered to a maturity. The assumption of course being that the bond will be paid at time of maturity.

This risk of being paid (or not) is usually compared against what many consider to be the risk-free rate of US Treasury securities. Thus, Treasuries represent a non-credit risk option as they are assumed to be paid; the government will simply print more money to redeem them. All other (US) bonds do not have this feature of printing additional money; therefore, they are considered spread products.

As you know I recommended selling your bond products (mutual funds primarily), marking March 6th as the high-water mark for bonds. To say that March was a volatile month borders on understatement, but we witnessed US Treasury notes and bonds trade at their all-time highs in March.

The ten-year, Treasury note receives the most attention in the marketplace. For most of 2020 the note yielded less than 1%, again, a low yield in anyone’s book (and a high price). But recently the yield has moved over 1% leading to, well, the focus of this letter.

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Our World Has Changed

June 17th, 2020 by Kurt L. Smith

Most of us come to realize that change is inevitable and adapting to change is a part of life. Sometimes change is like aging in front of a mirror:  it isn’t until you look back several years that you realize, yes, I have changed…I mean aged.

This, of course, is not what I am talking about. Today we have a sea change (literally), as well as one massive change after another. The world has changed and adapting to it will be key to our survival.

My focus here is on the bond market, which just happens to be the primary tool of our monetary authorities: The Federal Reserve and the central banks of the world.  Fiscal authorities are also joining the bond rush as governments issue bonds to finance their response to our changed world.

The fundamental change that happened in the bond market occurred in early March and was the subject of my April letter. US Treasury securities traded at yields of 0.70% and lower across all maturities from a few days out to the longest thirty-year maturity per Bloomberg. This extremely low (or no) yield means longer term bond prices were at their highest prices ever as the price of the bond includes, effectively, almost all of the income you would receive in the days, years or even decades to come for the bond.

But it is not just treasury bonds. Other bonds such as mortgages, corporates and municipals also benefitted by the high bond prices as the yield spread on those bonds in early March were at or near historical lows. Historically low spreads, together with the low (no) yields of the treasury base means bond prices on almost all bonds were their highest prices ever.

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