What happens to municipal bonds when rates go up?
Bonds and interest rates have an inverse correlation: as interest rates increase, bond prices fall. However, the more the Federal Reserve hikes interest rates, the better it is potentially for municipal bond investors.
Bond prices move in inverse fashion to interest rates, reflecting an important bond investing consideration known as interest rate risk. If bond yields decline, the value of bonds already on the market move higher. If bond yields rise, existing bonds lose value.
Nuveen, a TIAA company, maintains yields for municipals remain attractive despite a strong rally in November 2023. The company believes demand for municipal bonds could increase in 2024 as investors gain conviction that the Fed has ended its rate hikes. Nuveen expects the Fed to cut rates by 150 basis points in 2024.
During periods of inflation, if the inflation rate was greater than the coupon rate, it would be possible to lose money by investing in a municipal bond, because the interest earned on the bond would be less than the value the money was losing through inflation.
After two tumultuous years, we expect a municipal market recovery in 2024 and we believe municipal bond mutual funds will outperform other investment vehicles.
Municipal bonds, like all bonds, pose interest rate risk. The longer the term of the bond, the greater the risk. If interest rates rise during the term of your bond, you're losing out on a better rate. This will also cause the bond you are holding to decline in value.
Unless you are set on holding your bonds until maturity despite the upcoming availability of more lucrative options, a looming interest rate hike should be a clear sell signal.
Key Takeaways. Most bonds pay a fixed interest rate that becomes more attractive if interest rates fall, driving up demand and the price of the bond. Conversely, if interest rates rise, investors will no longer prefer the lower fixed interest rate paid by a bond, resulting in a decline in its price.
The answer is both yes and no, depending on why you're investing. Investing in bonds when interest rates have peaked can yield higher returns. However, rising interest rates reward bond investors who reinvest their principal over time. It's hard to time the bond market.
This supply constraint may increase the likelihood of solid performance in 2023. Looking ahead, we believe the long-term prospects of municipal bonds remain compelling. The eventual return of municipal market performance is likely indisputable; the only question is when.
How safe are municipal bonds now?
While municipal bonds are generally considered safe, they are not entirely immune to default. It's essential to research the financial stability of the municipality issuing the bond before investing.
2023 was quite a ride for the municipal bond market—one that produced a positive annual return despite significant momentum swings from quarter to quarter. [i] While rates peaked in October, dovish Fed messaging in December sparked another rally as investors priced in an approaching end to the Fed's tightening cycle.
1. Absolute rates are high now, but we expect them to move lower in 2024. There are two main reasons why we believe munis are an area of potential opportunity in 2024: high yields and strong credit quality. To illustrate, the yield-to-worst for the Bloomberg Municipal Bond Index, a broad based index, is 3.7%.
Municipals yields ended the week slightly higher across the curve --- with portfolio yields increasing roughly 1 to 4 basis points. Long term investors continue to realize additional yield further out on the curve.
Fixed-Income Investing Risks
The value of investments in fixed-income securities will change as interest rates fluctuate and in response to market movements. Generally, when interest rates rise, the prices of debt securities fall, and when interest rates fall, prices generally rise.
We expect muni issuance in 2024 to outstrip the $380 billion in 2023. Municipal borrowers have had time to adjust to higher borrowing rates and the higher cost of project construction. As a result, the deal size of the many projects shelved over the past few years will not only come to market, but they will be larger.
The general market backdrop for municipal bonds has improved as we enter 2024. For example, the Fed's indication of a gradual easing this year and a potential move towards lower rates should help reduce market volatility, aligning with longer-term trends observed during periods of lower inflation.
If you plan to invest in individual municipal bonds, hold them to maturity. Only if interest rates plummet and the value of your bonds skyrocket, should you consider selling them beforehand.
In a recession, munis also tend to have a benefit shared by other fixed income sectors with interest rate sensitivity. The Fed could start cutting rates as the economy falters. Bond prices move inversely to interest rates.
When an investor sells a municipal bond, there are potential financial consequences that should be taken into consideration. These include: Potential Loss on Principal — The market value of a municipal bond is governed by a number of factors, including those described above.
What is the downside of municipal bonds?
Municipal bonds don't hold up against inflation as well as stocks do. When inflation rises, a muni's fixed payment is less attractive. Still a chance of default. While default risk is very low, municipal bonds could still go into default.
The fixed rate rose to 0.4% in November 2022 so any I bond purchased after that date should be held. Likewise, you may want to hold on to I bonds issued between May and October 2023. Those I bonds have a fixed rate of 0.9%, which is the highest fixed rate in 16 years.
CDs are usually best for investors looking for a safe, shorter-term investment. Bonds are typically longer, higher-risk investments that deliver greater returns and a predictable income.
If sold prior to maturity, market price may be higher or lower than what you paid for the bond, leading to a capital gain or loss. If bought and held to maturity investor is not affected by market risk.
| Face Value | Purchase Amount | 30-Year Value (Purchased May 1990) |
|---|---|---|
| $50 Bond | $100 | $207.36 |
| $100 Bond | $200 | $414.72 |
| $500 Bond | $400 | $1,036.80 |
| $1,000 Bond | $800 | $2,073.60 |
