What Elevated Muni Yields and Tax-Loss Swaps Mean for Your Portfolio
The Signal
Inflation expectations are climbing again, and that helps explain why yields are not coming down and continue to move higher. The New York Fed’s Survey of Consumer Expectations, released Wednesday, showed the median one-year inflation expectation rising to 3.9% in September from 3.6% the month before, the highest level since May 2023. Views on the labor market improved at the same time, as workers saw a lower probability of losing their jobs and higher odds of voluntarily quitting.
That mix is one of the reasons yields have been elevated for the last two months. We expect Fed Chair Kevin Warsh to keep using rate moves to address the concern, and as of this writing we suspect there will be one more rate hike this year. Munis are still absorbing September, their worst month since 2008, and the 30-year benchmark yield, which crossed 5% during the selloff, sits near 5.1%.
Last week, we said a hot inflation reading or a Fed leaning toward more hikes could push yields higher before they settled, and that we would let the data set the pace. This week’s data points the same way.
What’s Driving It
A Resilient Market Under Pressure
The market mood is one of resilience under pressure. Equities remain close to record highs, but the macro backdrop has changed who is leading. Treasury yields are near multi-decade highs, oil is back above $100, and the dollar is surging, all underpinned by persistent geopolitical and fiscal risks and a Fed that remains tilted hawkish.
Wednesday’s strong 10-year auction offered temporary relief, but overnight pressure moved yields back to around pre-auction levels across the curve. Muni yields sit at their highs, 30 to 100 basis points above where they were a little over two months ago.
Tax-Loss Harvesting Takes Shape
BlackRock’s Pat Haskell says September’s rout gave investors a chance to cut their taxes and capture high yields, calling fixed income “sexy again” and munis “one of the most attractive.” Fund flows already show the strategy at work, as investors pull money from open-ended muni funds and move it into muni ETFs, which are seen as the easiest and most liquid vehicle for harvesting losses.
With the market sloppy and bid/ask spreads wide, we would look at swaps. Swapping paper to generate tax losses could benefit your overall tax situation.
Heavy Supply Meets Heavy Bid-Lists
Municipal issuance surged 19% year over year in September, even as geopolitical tensions, economic resilience, and inflation uncertainty pushed rates to multiyear highs and postponed several large deals. Concessions stayed selective as ETFs attracted record inflows. The two largest deals were the Alabama Toll Road at $3.786 billion, rated BBB, and the Dormitory Authority of NY at $1.877 billion, rated AA+.
Bid-lists remain elevated amid recent weakness and a laggard household response to volatility, resting near the extremes seen at the onset of the 2020 pandemic. Month-end trading was heavily one-sided until redemptions, quarter-end, and ETF-driven buying helped steady it.
October Has a History
October is historically a nexus of heavier trading volumes, accelerating pre-holiday supply, and softer reinvestment demand. Issuers report healthy investor interest, but bearish technical factors continue to favor buyers and push price performance lower. The Bloomberg US Municipal Index has had notable declines before, including the reflationary weakness ahead of the 2016 elections (down 1.05%), the term-premium debates of 2023 (down 0.85%), and the policy considerations ahead of the 2024 results (down 1.46%).
A heavy October calendar and lighter reinvestment demand could keep technicals challenging. Recent developments may help curb near-term bearish momentum, but the broader environment should keep offering tactical reasons for cautious, periodic entry once stability returns.
Our Take – Sloppy Markets
In our opinion, yields stay elevated through this month. Inflation expectations are rising, a heavy October calendar meets lighter reinvestment demand, and the Fed has shown it will answer with rate moves. We would plan around that rather than wait for it to change.
That is not a reason to step back. If you are seeking to lock in longer-term paper at these yields, this could be a great time to act. As the buyer, you will have plenty to choose from, and heavy bid-lists typically create higher yields. Stay patient and you could be rewarded.
Swaps deserve a look as well, and we expect more tax-loss harvesting ahead of the holidays.
Recommendations
Stay patient, stay with quality, and keep adding to your muni portfolio
We expect yields to remain elevated. Quality paper is available now, and a steady approach lets you add without chasing the market.
Add exposure cautiously as delayed selling and heavy issuance work through the market
Households are responding to the volatility, and new supply is still arriving. Add in measured steps and stay vigilant based on your personal objectives.
Maintain a conservative posture and plan for tax-loss harvesting
Expect tax-loss harvesting to build ahead of the holidays. Swapping paper to generate tax losses may suit some portfolios, and we would welcome a conversation about yours.
Take a hard look at call protection on every offering
Yields are elevated and have remained elevated. As you see paper that meets your objectives, look closely at the offering. If you are seeking to lock in yield with call protection, this could be your moment. 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.
