Munis rallied into the Fed’s hold, and a December hike is still in play. Here is what it means for your portfolio.
The Signal
Munis delivered a strong week, outperforming Treasuries across the curve as favorable technicals, tax-loss harvesting flows, and a dovish-leaning Fed hold pushed yields lower. The Bloomberg Municipal Bond Index (LMBITR) yield fell about 5.6 basis points, from 4.313% on October 23 to 4.257% on October 28, with positive total returns posted in each session – bottom line here, yields fell through the month.
The FOMC voted 10-2 on October 28 to hold the federal funds rate at 3.75% to 4%. Governor Lisa Cook and Cleveland Fed President Beth Hammack dissented in favor of a quarter point hike. Chair Kevin Warsh offered no clear signal of a December move, and made clear the Committee remains ready to act as circumstances require. The hold was somewhat expected, though it would not have surprised us to see a hike in October.
We think a December hike is likely, and with munis where they are today, we remain buyers as we do not see a hike impacting pricing much.
Last week, we pointed to reinvestment demand and tax-loss selling as the forces easing yields, and we said we still expected one more Fed hike before year-end. This week’s dissents and GDP data point in the same direction.
What’s Driving It
The Fed Reworks Its Calendar
Warsh also announced that, beginning in 2027, one of the FOMC’s eight annual meetings will be reserved for broad monetary policy strategy discussion, with no vote or statement. That leaves seven rate decisions in 2027 and six in 2028. Yields turned lower across the curve immediately after the announcement.
Munis have held steady this week, and we expect them to stay within roughly 5 basis points of current levels over the next week or so. Beyond that, we see yields grinding a bit lower over the next couple of months.
Strong Growth, a Cheaper Long End
The Fed’s hold was broadly supportive of the front end of the Treasury curve, but the longer end cheapened, with the 10-year yield rising from 4.99% to 5.03%. In our view, that rise does not preclude future hikes, particularly given the two hawkish dissents and the strong GDP print.
This morning, third-quarter GDP printed at 3.4% annualized, the fastest pace in a year and above the 3.2% Bloomberg survey median, driven by business investment and consumer resilience. It adds a hawkish data point to the backdrop.
Light Supply, Steady Demand
Over the last week, scheduled issuance totaled $13.9 billion, with notable deals from NYC, LA Schools, and KY Public Energy. Because rates have been higher over the last few months, we expect issuance to remain muted.
Investors are clearly buying paper. Muni bond funds recorded $1.6 billion of inflows for the week ended October 22, led by longer-term funds as investors buy the longer end of the curve to capture higher yields. High grade individual CUSIPs are also being bought while high yield paper is being sold, a shift we attribute to the narrowing spread between the two credit structures over the last few months.
Barclays indicated that some strategists were not surprised by the October rally, primarily because of how poorly September went. Yields on the MMD scale have fallen 17 to 49 basis points month to date, with short-term munis posting the largest gains. In our opinion, the rally has been supported by the lighter calendar, along with cash moving into the high grade muni market to capture above-market yields.
Tax-Loss Harvesting Continues
We have pointed to tax-loss harvesting as a key technical driver over the past few reports. Investors continue to sell weak paper from the September to early October selloff to realize losses, then rotate into individual bonds further out on the yield curve. We expect this trade to continue over the next month or so.
Our Take
Munis have richened materially over the last five sessions, driven by a lighter calendar, heavy cash positions moving into the asset class, and tax-loss harvesting paired with buying on the longer end of the curve.
We think the Fed hikes in December. The strong Q3 GDP print and the two hawkish dissents we saw this week keep that outcome alive. Even so, we remain buyers. At the yield levels we see today, we do not believe a December hike would necessarily have a material impact on pricing.
There are risks to this view. Stronger data could push the Fed to raise more than 25bps in December, longer Treasury yields could keep climbing from levels above 5%, and the lighter supply and tax-loss activity that have helped munis could fade. Any of these could push muni yields higher, and bond prices would fall along with them.
Incoming economic data, Treasury yields, and the pace of tax-loss activity are what we are watching most closely. We will keep you posted.
Recommendations
Keep buying high grade municipals
Cash is moving into high grade munis to capture yields that sit above where the market has been, and the spread between high grade and high yield has narrowed. We continue to favor high grade, and we do not expect a December hike to change that on its own.
Review tax-loss harvesting while the trade is in favor
If you hold bonds that lost value in the September selloff, now may be the time to realize those losses and rotate into individual bonds further out the curve. We expect this trade to continue over the next month or so, and we would welcome a conversation about it alongside your tax advisor.
Do not wait on the Fed
As mentioned, we think a December hike is likely, but at current yield levels we do not believe it would necessarily move pricing materially, so the decision alone does not argue for sitting on the sidelines. Reach out if you would like to discuss this in the context of your portfolio.
Use heavy supply to be selective
With issuance and bid lists expected to stay elevated, there should be plenty of paper to choose from. Take your time and buy what fits your objectives. Reach out if you would like to discuss any of this in the context of your portfolio.
Let’s Talk
If you would like to discuss any of the above in the context of your portfolio, reach out. This market environment rewards preparation — and that is exactly what we are here to help with.
