Chart of the Week

Weekly chart using economic data to address timely market topics from the Wells Fargo Investment Institute Global Investment Strategy team.

November 15, 2017

George Rusnak, CFA, Co-Head of Global Fixed Income Strategy

As Tax Negotiations Heat Up, Munis May Cool Down

As Tax Negotiations Heat Up, Munis May Cool Down (AAA-Rated Municipal/Treasury Yield Ratio)Sources: Thomson Municipal Market Monitor, 11/10/17. Past 12 Month Range to Comparable Maturity Treasury Securities: High - Low – Current. This chart was excerpted from the Investment Strategy report dated November 6, 2017.

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AAA Municipal/Treasury Yield Ratios

Recent events, such as new tax proposals, hurricanes, and increased supply, have not led to a pullback in the municipal market (to date) in 2017. In fact, municipals have outperformed Treasury securities since late July as interest rates have been rising. Municipal-to-Treasury yield ratios even have moved close to one-year lows—highlighting recent outperformance of this fixed-income class (see chart).

Why have municipal bonds performed so well recently? The focus on the potential for fewer tax deductions, longer-term benefits of infrastructure rebuilding proposals, and improved price discovery have fueled demand for municipals, despite initial headline concerns.1

What it May Mean for Investors

We believe that this outperformance will give way to uncertainty toward year-end. We expect volatility to rise as tax-policy negotiations progress, and as a result, we recommend a defensive approach to municipal investing today, with a focus on raising credit quality.

1 Price discovery is the process of determining a security’s market price (which depends on supply and demand). When demand is higher than supply, prices typically rise (and vice versa). For municipals, there recently has been high demand and constrained supply. Thus, a small supply increase has offered greater liquidity and firmer prices. (Longer-term and larger supply increases often have the opposite effect—flooding the market and causing price declines.)

Definitions

An index is unmanaged and not available for direct investment.

AAA rating: The highest quality debt, with minimal credit risk.

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

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