By Jim Colby
Portfolio Manager and Strategist, Municipal Bonds
Van Eck Associates Corporation
Can you remember a year where we as investors found ourselves staring, not only at the proverbial fork in the road, but also at a labyrinth of so many different possible outcomes, voiced by experts, that there seemed no clear path to choose? Where do we begin? Are we risk on or risk off, with: Omicron and Covid; global tensions with Russia and China; supply channels struggling to free themselves; the reforming of corporate America’s employment base; a trillion dollar stimulus being inserted into the U.S. economy; a looming political shift in Washington, imperiling domestic programs as the nation recovers from lockdowns? These issues and more will play into the narrative of the year to follow.
What You Should Know
The near-term catalyst for change is the Federal Reserve. Whether they end the stimulus gradually or with a sudden stop, their policy has already set in motion changes for the market and country that will influence investment decisions. Their declaration of as many as four rate increases in 2022 acknowledges that both the pressures of inflation and the characteristics of a changing economy must not be ignored.
What is Happening
Apart from the recent volatility in the equity markets, changes in the fixed income markets have already manifested themselves. We are currently in what is called a “bear flattener”1 market experience, where short- term rates are rising quickly, but long -term rates are rising ever so slowly. Why? A result of the declaration by the Fed; when they raise rates, it is specifically the short end of the Treasury curve where this change happens, while the long end is left to adjust to market forces. The relatively small adjustment at the end of the yield curve suggests that the impact of inflationary forces are not a long- term concern. The simple example below of the rates generated by our VanEck Short Muni ETF (SMB) and VanEck Long Muni ETF (MLN) during the past three months demonstrates exactly this result. The same is true in the high yield market as well.
Rates Generated by Short and Long Term ETFs Over 3 Month Period
Source: VanEck. As of 12/31/21. Past performance is not a guarantee of future result.
For standardized performance as of the recent month end and calendar quarter, please click here.
What to Do
We have been in an exceedingly low rate environment for many months, and the current adjustments mean that investments in the municipal market will be at more appealing rates. Where exactly to look to for the best outcome is evolving. What is clear is that, for the near term, while the markets (prices/yields) adjust to Fed policy changes, you may be best served by:
- Continuing to be invested (still little or no value in cash equivalents).
- Keeping an eye on “duration,” which is the measure of sensitivity to the change in interest rates.
Products that can cushion the impact of rising short rates with their positioning in the intermediate area of the market, such as the VanEck Intermediate Muni ETF (ITM) and the VanEck Short High Yield Muni ETF (SHYD), offer a way to manage risks and returns while the market undergoes this period of adjustment.
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Originally published by VanEck on February 3, 2022.
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1 Bear flattener refers to the convergence of interest rates along the yield curve as short term rates rise faster than long term rates and is seen as a harbinger of an economic contraction.
Prior to September 1, 2020, the funds were known as the VanEck AMT-Free Short Municipal Index ETF, VanEck AMT-Free Intermediate Municipal Index ETF, VanEck AMT-Free Long Municipal Index ETF, VanEck Short High-Yield Municipal Index ETF, VanEck High-Yield Municipal Index ETF, and the VanEck Municipal Allocation ETF.
An investment in the Funds may be subject to risks which include, among others, fund of funds risk, high portfolio turnover, model and data risks, management, operational, authorized participant concentration and absence of prior active market risks, trading issues, market, fund shares trading, premium/discount, general obligation bond, health care bond, water and sewer bond, special tax bond, transportation bond, private activity bond, sampling, index tracking, replication management, and liquidity of fund shares and non-diversified risks. The funds may be subject to following risks as a result of investing in Exchange Traded Products including municipal securities, performance of underlying funds’ investments, leverage, credit, high yield securities, tax, interest rate, call, state concentration and sector concentration risks. Municipal bonds may be less liquid than taxable bonds. There is no guarantee that a Funds’ income will be exempt from federal, state or local income taxes, and changes in those tax rates or in alternative minimum tax (AMT) rates or in the tax treatment of municipal bonds may make them less attractive as investments and cause them to lose value. Capital gains, if any, are subject to capital gains tax. A portion of the dividends you receive may be subject to AMT. For a more complete description of these and other risks, please refer to each Fund’s prospectus.
Taxable equivalent yields are used by investors to compare yields on taxable and tax-exempt securities after accounting for federal income taxes. TEY represents the yield a taxable bond investment would have to earn in order to match, after deducting federal income taxes, the yield available on a tax-exempt municipal bond investment. TEY = Tax-Free Municipal Bond Yield/(1 -Tax Rate).
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Fund shares are not individually redeemable and will be issued and redeemed at their NAV only through certain authorized broker-dealers in large, specified blocks of shares called “creation units” and otherwise can be bought and sold only through exchange trading. Creation units are issued and redeemed principally in kind. Shares may trade at a premium or discount to their NAV in the secondary market.
Investing involves substantial risk and high volatility, including possible loss of principal. Bonds and bond funds will decrease in value as interest rates rise. An investor should consider the investment objective, risks, charges and expenses of a fund carefully before investing. To obtain a prospectus and summary prospectus, which contain this and other information, call 800.826.2333 or visit vaneck.com. Please read the prospectus and summary prospectus carefully before investing.
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