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15-year high yields - Should I buy munis now? · UBS Trending

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  The Federal
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  Reserve recently hiked rates for the first time since 2023.
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  With that in mind,
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  how might that impact the municipal bond market?
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  Well, we're going to break down
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  where rates, risks and opportunities
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  can potentially go from here.
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  Right now on UBS Trending.
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  Hi, everyone, and thank you for joining me.
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  I'm Anthony Pastore and this is UBS Trending.
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  There's a lot to get to today.
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  My guest thankfully joining me is Dave Hammer from PIMCO.
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  Dave always really nice to welcome you to the program.
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  I know there's a lot going on, especially on the bond
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  market side.
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  So I'm glad to get started with you.
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  Nice to see you, Dave.
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  You too.
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  Anthony, thanks for having me.
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  So let's get into it. The Fed hiked rates.
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  We know that by now at 25 basis points on September 16th
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  and traditionally when you look at Muni bonds,
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  you know prices drop while new yields move higher.
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  Borrowing costs increase for state and local governments
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  when the Fed hikes rates.
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  What do you expect this time around versus
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  what we've seen traditionally isn't any different.
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  Or is this time
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  is this time a little bit different
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  than what we've seen in the past?
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  Well, I think it's a little bit different in that
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  the Fed is raising rates even though, core over
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  the next year still looks set to come back into the mid twos.
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  Headline inflation is obviously higher.
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  So a bit of,
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  you know, insurance,
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  hike leaning into to the risk management function.
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  But I think they've sent a decisive message to markets.
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  A lot of it came before the hike yesterday.
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  There were three hikes priced in prior to the move yesterday.
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  So they're really delivering on what markets have expected.
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  I think the 12-0 vote,
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  you know sends a message to markets that the fed is moving
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  not just on inflation but the risks of inflation.
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  And it sent a, you know,
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  somewhat reassuring message to the bond market,
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  the ten year treasuries, about five basis points lower,
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  the 30 year Treasury also lower.
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  In terms of, you know, muni yields and the move
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  as markets priced in these
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  hikes, yields are now 75 to 100 basis points
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  higher across the curve.
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  And initial yields today
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  are at generational highs.
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  You know going back all the way to 2000 in the long end,
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  to find this level of taxable equivalent yield,
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  a 30-year muni bond is upwards of,
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  5% to 5.25%.
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  That's about 8.5% pretax.
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  Portfolio that takes advantage of some credit
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  to get to get duration exposure down,
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  you can earn four and a half to four and three quarters
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  with about 7 to 7 and a half years of duration.
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  You know, again,
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  you'd have to earn upwards of 8% in taxable markets.
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  So, a big move in advance of the meeting.
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  I think the bond market generally has been reassured,
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  but by this move, interest rates are lower and muni
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  yields are higher.
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  What do you think has been driving performance so far this year?
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  Dave, when it comes to looking at the Muni bond side,
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  because we we could talk a lot about what's going on in taxable.
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  We could talk about what's going on in treasuries.
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  But how do you view this current opportunity set for Muni
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  in the context of your macro and rates
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  outlook, especially given the rate hike from the fed?
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  And like you said,
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  the market had already been pricing in 2 to 3 rate hikes
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  for a few weeks now.
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  Yes.
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  So the
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  you know,
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  the muni market started the year
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  relatively rich versus taxable fixed income.
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  So in January February this year
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  we were actually reducing short term high quality
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  muni moving into treasuries in the portfolios that
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  allowed us to do so.
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  You know, two things changed here.
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  Number one, obviously, the move in interest rates,
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  both the IGI muni index and the Barclays AGG taxable
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  index are down about one and a half to 1.75%.
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  But in order for that, you need to have moved
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  from relatively rich to relatively cheap.
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  Using the muni treasury ratio.
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  Just as a simple measure,
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  the ten year muni treasury ratio has gone
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  from the low 60s to the mid 70s,
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  and that's partially due to rates that the other parts
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  due to supply.
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  This is a record supply year for the muni market,
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  forecasting somewhere in the neighborhood of about $600 billion
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  and in total tax exempt debt, last year was a record.
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  This would be about 10% higher than that.
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  And the time period that we're in right now is technically,
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  you know, relatively weak time of the year. There's less,
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  reinvestment capital from
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  bonds maturing and coupons being reinvested back into muni funds.
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  So it's a net positive supply period.
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  It's come while rates are going up.
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  So we see a, you know, a really attractive opportunity
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  and high quality portions of the muni market to lock in and earn
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  higher taxpayer yields and also better relative value.
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  You know, it's the one exception would be the lower quality
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  portions of the high yield muni market,
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  credit spreads in the muni market.
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  If you look at high yield
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  spreads of muni bonds versus investment grade,
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  munis are the tightest they'd been a decade.
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  And we see rising default rates and some of that,
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  those lower quality portions of the market, you know,
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  there may be opportunities there.
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  And, and we've seen some in areas
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  like senior living, but for the most part,
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  our portfolios are up in quality.
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  You're not getting paid to take a lot of excess risk.
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  And we advise our, our clients, you know, do the same.
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  We've had an unprecedented period of,
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  economic growth.
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  You know, that won't last forever.
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  And you're not getting paid a lot
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  to to take some of those low quality credit risks.
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  And, you know, you talked about these spreads
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  being historically tight, Dave, which,
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  you know, we've been looking at
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  for quite some time now,
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  you said about a decade or so since they've been this tight.
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  How are you thinking about credit risk in that environment?
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  Yeah.
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  So that, you know, the IG portion of the muni market
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  is in excellent shape.
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  Record rainy day funds, record reserves.
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  State local governments are still benefiting
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  from a combination of, record tax collections.
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  Tax collections today are 40% to 50% higher
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  than they were pre-pandemic.
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  But in addition to that, there was a lot of federal relief
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  that was, allocated to state and local governments
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  with the expectation that tax collections would actually decline.
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  So all of those relief dollars have gone
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  to really strengthen state and local government balance sheets.
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  So overall, the IG portion of the muni market
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  is some of the best credit conditions I've seen in my career.
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  But the tide is beginning to go out.
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  This is the last year that federal relief
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  will flow through state and local government budgets.
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  Some have used that money responsibly, some have not.
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  Some have built up what we think will be very large
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  budget deficits over the next few years.
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  So it's a good time to de-risk.
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  And then just coming back to the lowest quality
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  portions of the high yield muni market,
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  you know, there are a lot of very risky deals
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  that were sold into the market between 2016 and 2021.
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  Rates were low.
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  A lot of high yield
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  muni funds are trying to sustain their their dividends.
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  We see, you know, many of those sins
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  committed years ago
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  really coming home to roost in the next year or two.
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  It's already begun.
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  And the senior living portion of the high yield
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  muni market, where default rates have ticked up to 9 to 10%,
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  we see large scale project finance or speculative deals
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  that were done back then was probably the next shoe to drop here.
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  And because yields are so high and there's so much to choose
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  from, the idea base,
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  you really don't need to be a hero here to lock in, yields
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  and ensure that you're not just earning a high yield today,
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  but you're actually going to get to keep your investing capital,
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  not suffer a permanent loss to T or any BS.
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  That's really a, you know, the way that we're looking at,
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  you know, all markets but but munis, especially excellent.
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  Dave.
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  And just to kind of as a point of reference, our chief investment
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  officer here at UBS does expect that the fed is going to raise
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  one more time in December, likely another 25 basis points.
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  But specifically with Muni,
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  you know, they're talking about technicals.
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  They expect them to weaken further, in the near term.
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  And they're looking at higher quality Triple-A rated bonds.
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  Given that, you know, what we're thinking here and what you see
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  as the backdrop of the markets,
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  how are you positioning portfolios across duration?
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  The yield curve, which has flattened a little bit since the fed
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  you know, hiked rates, overall credit quality.
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  Where are you seeing there's opportunities
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  where you kind of avoiding at this point?
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  Yes, I think we would agree with the UBS team.
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  This is a period of market weakness
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  because there's a big,
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  big supply surge and net positive supply surge and inflows
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  into most muni strategies
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  as interest rate volatilities picked up.
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  They've slowed down. So there's a lot of supply.
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  There's less demand that explains cheaper relative valuations.
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  We're taking advantage of that by leaning into duration.
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  You know we're a bit overweight today in our portfolios
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  because of muni cheapness versus interest rates.
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  And yeah, you mentioned that UBS team calling for,
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  an additional hike, maybe two that's just about fully priced
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  into the market today.
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  So you're getting paid to take those risks.
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  We really like opportunities in the meeting market
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  where we can get more yield with less sensitivity
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  to the long end of the US Treasury market.
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  The Treasury curve is flat.
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  The median curve is steeper.
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  But long dated munis are, correlated to longer treasuries.
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  Are we seeing less value?
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  So, you know, one sector we like quite a bit
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  the prepaid gas market
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  that's an opportunity to lock in four and a half to 5% tax
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  where yields
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  with bonds and maturities typically more like 7 to 10 years,
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  there's also opportunities to buy bonds with shorter call dates.
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  A 15 to 20 year maturity.
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  With a five year call,
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  you can get 90
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  and 95% of the yield that you would get in a 30 year maturity,
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  with a ten year call,
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  but with about half of the interest rate sensitivity.
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  So,
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  I think it's important that investors
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  look to take advantage of these yields,
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  but do it in a way where you don't necessarily
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  have to bet on a 10 or 12 year duration strategy that,
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  you know, could still suffer if there's more term premium
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  priced into the market.
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  If we were to see longer dated taxable risks sell off
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  relative to,
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  you know, pretty attractive bonds in the 5 to 10 year
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  part of the curve. Yeah.
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  And by the way,
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  I should also add,
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  that our CIO also agrees with you on the prepaid gas bonds.
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  They find those pretty attractive right now.
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  And my gosh, these payouts, it's just unbelievable.
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  Dave.
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  And we we've been
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  you and I have been doing this for a long time together.
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  And, you know, I think this is one of the most exciting
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  bond markets we've seen in probably my whole career.
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  It's just fascinating to watch how it's all unfolding in front
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  of our eyes.
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  Yeah, I couldn't agree more.
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  You know,
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  we love the muni market because it's incredibly inefficient
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  and adding some interest rate volatility, some low
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  volatility record new issue.
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  You know, there's
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  inefficiencies are,
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  you know, as large as they've really ever been.
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  Yeah. Dave, thank you very much.
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  Always great to get your insights Pimco's Dave Hammer
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  good to see you my friend.
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  Hopefully we get together soon.
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  Thanks, Anthony.
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  Thanks, Dave.
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  Good to see you.
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  And for more information, everybody
• 11:17
  and everything coming out of UBS, our chief
• 11:20
  investment office, and our great partners like Pimco.
• 11:23
  Please visit our website at ubs.com/views.
• 11:26
  Plus you can follow us on social media.
• 11:28
  We're on LinkedIn and Facebook.
• 11:29
  Plus the studio has its own dedicated Instagram channel.
• 11:32
  You can follow us @UBSTrending.
• 11:34
  Lots of great content there for you.
• 11:36
  And as always,
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  if you do have any questions
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  about what Dave and I spoke about today
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  or anything else
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  going on in the markets these days,
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  please make sure you're reaching out to your financial advisors.
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  Until next time, I'm Anthony Pastore.
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  Have a great rest of your day
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  and remember to keep your eyes on what's trending.
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  We'll see you soon, everybody. Thanks.