(Bloomberg) — Growing expectations that the Federal Reserve will hold off on further interest-rate cuts are foiling what should have been a strong month of municipal bond returns.
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Benchmark municipal bond yields climbed as much as 25 basis points last week and edged higher again on Monday. The muni market is joining a bond rout that pushed long-dated Treasury yields above 5% for the first time in more than a year. Those on similarly dated municipals topped 4%, the highest since November 2023, according to data compiled by Bloomberg.
On Friday, monthly US jobs data exceeded projections, capping a surprisingly strong year for the labor market and adding more reasons for the Fed to dial back rate cuts, driving yields higher. Investors are also building in expectations that the policies of President-elect Donald Trump will foster quicker growth and inflation.
“There’s nervousness on the path that the Fed will take and nervousness on the path that the new administration will take,” said Sweta Singh, portfolio manager at City Different Holdings. “There’s nothing that the market hates more than uncertainty, so I think that is reflected in yields, both in the Treasury market and in the muni market.”
In the aftermath of the jobs data, economists have pared forecasts for cuts. For example, Bank of America, which previously expected two quarter-point reductions this year, no longer expects any.
“The jobs report has likely got the Fed on hold, and that will probably make investors a little more hesitant to jump all in on fixed income, which has a direct impact on munis – despite the fact that the yields, especially for those in higher tax brackets, do make sense,” said Chad Farrington, co-head of municipal bond strategy at DWS Group.
The selloff has put a damper on returns, sending an index of state and local-government securities down 0.66% since the start of the year, Bloomberg index data show. January is historically a strong month in the muni market, as localities tend to get a slow start on selling new bonds just as buyers have interest and principal payments that they typically seek to reinvest. On average over the past decade, the muni market has earned about 0.5% in January.
“Munis are a passive victim of Treasuries‘ own issues,” wrote municipal-bond strategists at Bank of America led by Yingchen Li and Ian Rogow.
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–With assistance from Elizabeth Rembert.
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