The market euphoria brought on by President-elect Trump (rising equity markets and bond yields) has now moved on to the reality of President Trump. The spadework of working with Congress to move his agenda has begun.
Taxable Yields
After the election, the U.S. 10-year Treasury increased in yield from 1.75% to 2.60%, but has since returned to 2.45%. The 30-year US Treasury bond increased in yield from 2.55% to 3.18%, and is 3.04% currently.
The fast spurt upward was a combination of the bond market’s starting to discount a higher growth rate in the United States and a potentially higher inflation rate. We feel that the bond market also built in a yield premium to compensate for the uncertainties that the Trump presidency brings to markets in general and fixed-income investing in particular.
Part of this more recent decrease in yields is a reversion to the mean. There is no question that the move up in yields was very swift by almost any metric, and certainly there may have been some overshoot by the markets.
Moves such as the President’s withdrawal from the Trans-Pacific Partnership on Monday January 23rd are a shot into the market. This decision worries markets, and the traditional flight to safety in the form of US Treasury securities is a result. The idea of the bond markets moving to a terminal point, rates-wise, immediately after the election is now being offset somewhat by the flight to safety. We will see if other “first moves” by the administration produce similar effects.
Tax-Free Yields
We wrote in December 2016 about the spiking of muni yields due to bond-fund selling. AAA-rated muni yields increased in the 10-year range from 1.70% before the election to 2.55% in early December before dropping to the current 2.33%, and the 30-year level rose from 2.52% to 3.34% before falling back to 3.05%.
We know that the plethora of high-grade, long-term bonds in the AA-rated range that were trading at 4% plus yields has shrunk quite a bit. We believe a number of factors played into the partial muni rebound. One factor is the drop in supply so far in 2017.
Part of this drop is seasonal, but there is also the perception that there will be less supply in refunding bonds this year – for the simple reason that at the now-higher interest rate levels, many refinancings do not work. Thus, part of the rate rise becomes self-curing.
In addition, the normal rollover at year-end from maturating bonds, called bonds, and coupon payments is also at work. We saw many taxable accounts, such as foundations and charitable groups, also buying tax-free munis because many of the yields were higher than those available in the taxable market in late November/early December.
We know that, in addition to grappling with fears of growth and inflation, the muni market also faces the possibility of future supply from infrastructure programs and possible cuts in federal marginal tax rates. We believe the market recognized that with many high-quality bonds trading at the 4.20% range in December, with a 3.10% Treasury, was a giveaway; and at those levels (135% muni/Treasury yield ratios), any tax cut was essentially inconsequential.
We will monitor developments in infrastructure plans and tax cuts as they go forward. But it will take some time to craft these plans. Again, we had a market that got ahead of itself.
Probably the best sign that the smoke has started to clear in the muni market is that fund flows into municipal bond funds turned positive last week after eight consecutive weeks of outflows. One week does not make a trend, but the uptick in fund flows is a welcome sign.
We will continue updating readers on the President's first hundred days.