“Municipal bond investors are banking on an expected March uptick in sales of US state and local government debt to help cheapen the market from current nosebleed levels. Ten-year, top-rated muni bonds are yielding less than 60% of comparable US Treasury securities after demand for tax-exempt debt drove valuations on the securities to a near record. The Muni-Treasury ratio, a key measure of relative value, has averaged about 83% over the last five years. The lower the ratio, the more expensive municipals are, all things being equal”.

The above quote from Bloomberg’s daily ‘Municipal Market Brief’ illustrates the relatively rich state of intermarket ratios between AAA-rated ten-year municipal bonds and US Treasuries. At 59% ratio (chart) a top tax-bracket investor retains the same amount of net income whether he owns a AAA municipal or US Treasury bond.

Given a choice we think an investor should opt to purchase the more liquid ten-year Treasury instead of ten-year AAA municipal debt. Ten-year intermarket ratios have averaged 83% over the last five years and we see the potential for reversion to the mean.

We find twenty-to-thirty-year A to AA rated municipal debt to be more appealing. For example during the Feb 26^th week AHW purchased AA rated Pennsylvania Econ Dev Fin Auth 4.375% due in 2053 at a 4.56% yield. County guaranteed debt, a 4.56% yield equates to a taxable equivalent yield (TEY) behind 7.50% for maximum tax bracket payers. Thirty-year Treasury debt yields only 4.41% while comparably rated corporate debt yields less than 6.00% meaning the top tax-bracket municipal investor retains more net earnings.

We acknowledge that thirty-year AAA municipal ratios also sit at tight historical ratios. Still, TEY initiating yields behind 7.00% readily exceeds the net income available from alternative fixed income asset classes while also positioning investors smartly on the yield curve for an eventual Fed easing, whenever that may occur. Further total municipal new-issuance Year-to-Date in 2024 is the most since 2020. It is always smart to be a buyer when supply is heavy versus light.

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Steve Wool