Vanguard’s Malloy Says Muni Yields Bolster Second-Half Outlook

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(Bloomberg) — Attractive yields and strong credit fundamentals are setting the municipal bond market up for a solid second half of the year, said Paul Malloy, the head of municipals at The Vanguard Group Inc. 

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Investors in the highest tax bracket can collect a broad muni-market yield of 3.62%, equivalent to 6.1% on a taxable security. The latter surpasses US corporate bonds, yielding 5.26% and having a higher default rate. 

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“You’ve got some really good yield back into the muni market and you’ve got a pretty steep curve,” Malloy, who oversees $300 billion in muni assets, said in an interview. “You’re paid to wait in the tax-exempt space and for whatever reason you get any sort of major economic volatility, it still serves as ballast in a broader fixed-income portfolio.”

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Investors have poured $46 billion into the muni market this year, running at the second-highest rate on record, JPMorgan Chase & Co. wrote in a June 5 report. The market’s 1.74% total return year to date bests a 0.08% return for US corporate bonds and close to 0.5% loss for US Treasuries, according to Bloomberg Indexes. 

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The nearly 1.9 percentage point difference between 2-year and 30-year muni yields has attracted cash to long-end of the market, Malloy said. The run-up in stocks has also led some investors to reallocate to munis to keep their portfolios in balance. The municipal debt market could end the year with a 3.5% return, he said.

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Malloy also touched on the following: 

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Prepaid Gas Bonds

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Google parent Alphabet Inc.’s involvement in a prepaid energy has drawn greater attention to deals that allow utilities to lock in prices. More pre-paid energy deals are in the offing, he said.

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Data Centers

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Data centers have turned to every corner of the US debt market, apart from the municipal market, to finance facilities that house thousands of servers. US Internal Revenue Service rules on the use of proceeds from tax-exempt debt preclude data centers from tapping the muni market, Malloy said. Federal tax laws restrict private companies from using tax-exempt debt for business operations.

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Property Tax Revolts

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A proposal by Florida Republican Governor Ron DeSantis to slash local property taxes, could benefit cities, towns and school districts if the AAA-rated state backs their bonds, said Malloy. The elimination of property taxes without a state backstop or replacement revenue source would lead to bond defaults and “huge political consequences,” he said. 

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