Latest / Inflation and Your Money with Fexingo: Protecting Purchasing Power and Beating Inflation / How Inflation Is Quietly Eating Your Municipal Bond Returns
Transcript
- Lucas: You know, municipal bonds are one of those investments people love for the tax break, but I think there's a quiet problem that gets overlooked. Luna: You mean the interest is tax-free at the federal level, sometimes state, but inflation still eats away at the spending power, right? Lucas: Exactly. So the market's pricing inflation expectations into bonds — the 10-year breakeven rate is around 2.26 percent right now, as of July 24th. That's down a hair from 2.28 a few days ago, but it's still telling us that investors expect inflation to average above two percent for the next decade. Luna: And the latest CPI print was 332.6 for June, down a bit from May's 333.98. So headline inflation is cooling, but core is sticky around 336. Lucas: Right. So if you're holding a municipal bond yielding three percent, tax-free, your real after-inflation return could be less than one percent. That's not terrible, but if inflation picks up again — and we saw oil prices ripping higher this week, which has some analysts raising the odds of a Fed rate hike — those real returns could turn negative. Luna: And that's before we even talk about price risk. If the Fed does hike, bond prices fall. Lucas: Right. So the double whammy: inflation erodes the purchasing power of your interest, and rising rates erode the principal value if you need to sell before maturity. For a supposedly safe asset, that's a lot of hidden risk. Luna: I know a lot of retirees and high-income investors lean on munis for that tax advantage. What are they supposed to do? Lucas: Well, one option is floating-rate municipal bonds. Their coupons reset periodically, so they adjust with short-term rates. With the fed funds rate at 3.63 percent, that's actually decent. But you're trading some price stability for income that can keep up. Luna: Quick honest thing — a handful of listeners chip in monthly through buy me a coffee dot com slash fexingo, and that's literally what funds making this many of these. Lucas: Yeah, it's true. No ads, no sponsors, just listeners who find value in what we do. So if these conversations have helped you think about inflation differently, that's the only reason we keep going. Luna: And we mean that. Alright, back to munis — so floating rate helps on the income side, but what about the inflation piece? Lucas: Another strategy is to pair municipal bonds with Treasury Inflation-Protected Securities, or TIPS. Your TIPS adjust for inflation, but the interest is federally taxable. If you hold them in a tax-advantaged account like an IRA, you get the inflation adjustment tax-deferred. Luna: But TIPS yields are still modest. The 10-year real yield is around 1.6 percent or so. Still, that's a guaranteed real return. Lucas: Exactly. And you can build a bond ladder — stagger maturities so some bonds are maturing each year. That way you can reinvest at higher rates if inflation persists. It's not a perfect solution, but it smooths things out. Luna: And if you really want to beat inflation, you might need to consider equities or real assets, but that's a different risk profile. Lucas: Right. For someone who really wants the tax-free income, floating-rate munis and a TIPS overlay can work. But the bottom line: don't assume your muni bonds are safe from inflation. Check your real return — after inflation and after taxes. You might be surprised. Luna: So what's the takeaway for someone listening right now? Lucas: Look at the breakeven inflation rate, look at the CPI trend, and decide if you're comfortable with one percent real returns. If not, it's time to adjust. The bond market is telling you something — don't ignore it.