US investors looking to match the long-term returns provided by equities need look no further than the seemingly modest municipal bond market.
Case in point: the $1 billion deal sold by New York City this week. The Big Apple — rated AA by two ratings companies — sold 30-year debt that was priced to yield 4.35%. It sounds modest, but with tax adjustments, the richest New Yorkers snapping up the securities earned yields equivalent to 10% taxable debt, an online tool from Eaton Vance Management shows.
The $4 trillion municipal bond market, like other parts of the fixed income universe, is offering elevated yields not seen in years. But the state and local debt market has an added allure that other asset classes don’t: the income is tax-exempt. That means that the yields on muni bonds are even higher after adjusting for taxes. And the higher your tax bracket, the more attractive the bonds look.
The stock market has averaged returns of just under 10% annually over the last 30 years, data compiled by Bloomberg show. Richer yields will draw investors dipping into both municipal and equities markets toward state and local debt, according to Rick Taormina, a portfolio manager at JPMorgan Chase & Co.’s asset management arm.
It’s “pretty significant for a New York taxpayer to avoid both federal and state tax and local tax for that piece of paper,” said Taormina, who covers tax aware strategies. “That is just tremendously attractive and it was very well received.”
The bonds offer somewhat elevated yields relative to the highest rated credits to account for the risk involved. The 30-year maturity priced over 60 basis points higher than AAA debt.
Residents of New York, home to one of the world’s wealthiest cities, shoulder the highest tax burden among US states, with over 12% of personal income going toward a variety of taxes, according to a WalletHub analysis.
An economic downturn could also help spur a flight into fixed income, Taormina added, noting the Federal Reserve’s battle with inflation could pressure the stock market forcing investors to take their “chips off the table.”
Other debt instruments, such as corporate bonds, can’t compete with the current muni allure. For New Yorker City residents with taxable income over $25 million — securities would need to yield about 9.8% to match the yield on the New York City muni deal’s 30-year maturity, Eaton Vance’s tool shows.
There’s still a benefit for those of more modest means. For married couples living in the city and earning $100,000 and filing taxes jointly, taxable bonds would need to yield above 6% to compete with the NYC muni yield. Data compiled by Bloomberg shows the yield-to-worst on an AA rated corporate bond stands at about 5%.
“Munis offer impressive yield pick-up over similar rated taxable bonds up and down the yield curve,” said Brandon Fritz, managing director and institutional portfolio manager at Morgan Stanley Investment Management,
Investors are already taking notice as they flocked to the New York City sale of $1 billion of general-obligation bonds underwritten by Loop Capital Markets this week. The city received over $789 million of orders during a reservation period for retail investors and another $5.1 billion in a session for the institutional side, according to a statement from the New York City comptroller’s office. During the marketing of the transaction, yields were reduced by as much as 10 basis points.
Still, last week’s muni selloff signals there are risks for the market as Wall Street strategists weigh the potential for a soft landing and the possibility of further interest-rate hikes. An uptick in debt issuance during the fall could also add pressure.
JPMorgan’s Taormina remains upbeat as buyers tend to pounce on higher yields after market routs.
“If we do get elevated supply in the fall, we actually think that’s a tremendous buying opportunity because of where rates are ultimately and what those taxable equivalent yields are,” he said.
--With assistance from Jill R. Shah and Martin Z. Braun.
(Updates to add pricing details in sixth paragraph.)
