Chart of the Week
Weekly chart using economic data to address timely market topics from the Wells Fargo Investment Institute Global Investment Strategy team.
George Rusnak, CFA, Co-Head of Global Fixed Income Strategy
As Tax Negotiations Heat Up, Munis May Cool Down
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.)
An index is unmanaged and not available for direct investment.
AAA rating: The highest quality debt, with minimal credit risk.
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