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Inflation Pressures In The Market

And how it relates to Municipals

As the Federal Government begins to announce projects such as the American Jobs Plan, investors have begun to pay increasing attention to inflationary pressures in the market. Unprecedented stimulus packages aimed at providing economic relief to the individuals, businesses and municipalities that were affected by the COVID-19 pandemic coupled with record liquidity and support from the Federal Reserve have started to have an effect on both the PPI and CPI.

As indicated in the graph below, month-to-month changes in Treasury Yield rates tend to be somewhat positively correlated to month-to-month changes in CPI with a correlation coefficient of .31.

Inflation Pressures

As inflationary pressures begin to mount, issuers may want to consider the effects of inflation on Treasury Yields. Although record supply/demand imbalances have put downward pressure on municipal bond yields, as Treasury yields begin to rise due to investors’ anticipation of above average inflation, municipal bond yields may begin to follow suit.

While Treasury and municipal bond yields tend to temporarily diverge from each other occasionally, as they are at this time, an analysis of the long-term history of the two-time series show that they often tend to
converge following periods of divergence.

Given that there is a chance of inflation related rises in rates on the horizon, issuers may want to consider locking in current low rates and savings through a forward delivery refunding or taxable advance refunding structure. These structures allow issuers to lock in current rates when refunding bonds, even if the bonds being refunding are not currently callable.

Author: Gurami Kiladze

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