Gotelli: Muni ‘belly’ offers value as front, long rich

Joe Gotelli, vice president and senior portfolio manager at American Century, identified the middle of the municipal yield curve as the most attractive area in recent weeks. Between mid-June and July he observed the front and long ends move to richer valuations as Treasury yields climbed and investor inflows into municipal debt remained strong.

Gotelli quantified the mispricing: two-year muni bonds trade about 1.5 to 2 standard deviations rich relative to historical norms, while 30-year munis sit roughly 1 to 1.5 deviations rich. He added that the AAA municipal benchmark has drifted into richness versus Treasuries.

He pointed to two main drivers. Demand from investors seeking tax-advantaged income lifted muni flows, and volatility in the taxable bond market pushed taxable-equivalent yields higher, drawing more capital. The front end, he noted, has largely ignored the recent rise in Treasury yields.

On credit, Gotelli flagged growing dispersion across issuers and stress in certain high-yield muni sectors. He reported an uptick in downgrades among some local governments dealing with post-pandemic budget pressures and inflation and emphasized that security selection is important to manage those risks.

American Century offers municipal exposure through ETFs including the American Century Diversified Municipal Bond ETF (TAXF) and the American Century California Municipal Bond ETF (CATF), each charging 27 basis points. As of July 14, TAXF’s 30-day SEC yield on a taxable-equivalent basis at the highest federal rate of 40.8% was 6.28%. CATF’s taxable-equivalent 30-day SEC yield at a 54.1% marginal tax rate was 7.6%.

Gotelli noted that geopolitical tensions involving the United States, Israel and Iran have added occasional volatility. He also observed that continued inflows this year have supported the muni market and helped push yields and valuations richer in parts of the curve.