It would be enlightening to examine several of the interesting events that have been unfolding in the municipal bond market. Much of this information was either provided by or verified by Dick Dobbins, president of Municipal Market Data Inc. in Boston.
In a macro-view of the muni market, from mid-December of 1982 until last summer, the tax-free market outperformed the Treasury market by 20 percent. Since last August, the muni market, led by the revenue sector, has relinquished a substantial part of that gain by giving back 33 percent of the advance. Perhaps this is an overdue correction, and we are back to a more normal relationship. On a relative basis, this price retreat has made the tax-free returns more attractive versus the returns on taxable Treasuries.
For example, a 20-year AAA-rated general obligation bond (GO) is now returning 81 percent of the yield on a comparable 20-year taxable Treasury. Over the past 12 months the average return was 76 percent of the yield on a Treasury. Similarly, the yield on a 20-year electric revenue bond is now 90.3 percent of the yield on a 20-year taxable Treasury. During the past year the average return was 83.2 percent.
Another noteworthy event is the flood of new revenue bond issues into the market, led by electric revenue and housing issues. This new-issue glut has forced dealers to carry large unsold positions of bonds. Until the past few weeks, only a few new high-grade (AAA- and AA-rated) GO issues were marketed. Consequently, on a relative basis, the high-grade GOs have become expensive when their yields are compared with the much more generous yields available on the revenue issues. For tax swappers, this affords investors the opportunity to sell high-grade GOs and purchase electric revenue issues, and in the process pick up higher yields and perhaps outperform the GO issue on a dollar-appreciation basis as well.
Next, the preponderance of revenue issues has changed the structure of the yield curve. The decline of the federal funds rate has pulled down other short-term interest rates, including those for tax-exempts with maturities of one year or less. At the same time, the large tax-free revenue loans are heavily weighted with bonds in the longer 25- to 30-year maturities. As a result, the yield curve has become very steep, offering increases in yield of 325 basis points or more when going from the one-year to the 30-year maturity.