(Bloomberg) -- The last time the municipal bond market rallied so much, it was Paul Volcker — and not Jerome Powell — who was winning a war on inflation.
Fueled by growing speculation that the Federal Reserve has tamed inflation enough to start cutting interest rates next year, everything from Bitcoin to tech stocks to Treasuries have rallied sharply this month. For state and local government debt, it has been a particularly heady run: They’ve delivered a return of more than 5% in November, the best month since January 1986.
The swift, surprising surge has been enough to lift returns and erase losses. The Bloomberg muni index is now up nearly 3% for the year, a rebound from a loss of 2.2% at the end of October. Benchmark yields for muni bonds due in 10 years reached below 2.74% Wednesday, the lowest since mid August.
“It’s been a very good month,” said Cooper Howard, fixed income strategist at Charles Schwab. “The significance of the move is that it’s going to pull us back into positive total returns for the year and that will have implications for 2024.”
The Fed — now led by Powell as chairman — began aggressively raising rates in March 2022, leading to the fastest pace of rate increases in 40 years. The central bank has yet to cut borrowing costs even as US inflation has broadly slowed this year. Traders and investors are increasingly expecting that this tightening cycle is at its end and the Fed may cut rates next year.
Global bonds are also soaring, now at the fastest pace since the 2008 financial crisis. A Bloomberg gauge of global sovereign and corporate debt has returned 4.9% in November, heading for the biggest monthly gain since it surged 6.2% in the depths of the recession in December 2008.
A “very low” supply of new bond sales from state and local governments provided an additional lift, Howard said.
When returns turn positive, funds begin to see investor cash come back, Howard said. Investors added about $292 million to municipal-bond funds during the week ended Nov. 22, marking a reversal from 11 consecutive week of outflows. according to LSEG Lipper Global Fund Flows data.
Looking ahead, December may not have as much momentum as November but the last month of the year has tended to stay in the green. December muni returns have been positive since 2014, according to Bloomberg Intelligence.
“Municipal bonds are riding high with an almost 5% return for November, a record best, creating a bit of buzz for the oft-overlooked asset class,” Karen Altamirano, an analyst with Bloomberg Intelligence, said in a report. “The tremendous reversal of fortune and subsequent run of wins has muni buyers tripping over themselves.”
Rate Cut Bets
A similar November trend has played out in the previous two years, Eve Lando, portfolio manager for Thornburg Investment Management, said in an interview. After three months of losses from August through October, munis rallied in November in 2021 and 2022. Last year, the end-of-year gains were partly due to increasing expectations that the Federal Reserve would cut rates in 2023, which did not occur.
Bond traders now have bumped up their bets on a quick end to the tightening cycle and are pricing in the first interest-rate cut by May. Amid expectations for rate cuts, tight muni supply compared to demand, so-called tax harvesting and limited trading days left before the end of the year munis are rallying, Lando said.
“People just want to be fully invested,” Lando said. “It is an absolute bond grab out there.”
--With assistance from Garfield Reynolds.
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