How Can Muni Investors Capitalize on Yield Curve Conditions?

By Stephanie Wang, Deputy Portfolio Manager

The shape of the yield curve is creating tactical opportunities—these two strategies can help municipal bond investors capitalize ahead of the Fed’s potential easing cycle.

Historically, the inversion of the yield curve has been a precursor to shifts in economic conditions and monetary policy. While the U.S. Treasury yield curve remains inverted, we believe that the spread between 2-year and 10-year yields (the “2s/10s”) peaked in June 2023.

Opportunity Knocks: Spread Between 2-Year and 10-Year Yields Appears to Have Peaked in June 2023

US Treasury 2s10s Spread

Spread Between 2-Year and 10-Year Yields Appears to Have Peaked in June 2023

Source: Bloomberg, as of 2/29/2024.

Meanwhile, the intermediate portion of the municipal bond curve has experienced a recent re-steepening. Notably, the “5s/15s” spread has surpassed its 5-year average level.

Steepening Intermediate Muni Yields Present an Additional Opportunity

Muni AAA Curve Spread (in bps)

Steepening Intermediate Muni Yields Present an Additional Opportunity

Source: Bloomberg BVAL AAA muni curve, as of 2/29/2024.

Given the current dynamics of the yield curve, we believe these two tactical allocations can help municipal bond investors capitalize on the current environment ahead of the Fed’s potential easing cycle:

  • Barbell strategy that includes both short-term and long maturity municipal bond portfolios to limit reinvestment risk and increase yield without extending duration.
  • Roll down strategy that takes advantage of the recent re-steepening of the intermediate portion of the municipal bond curve.

Barbell Strategy: A Flexible Approach to Capture Higher Yield (Without Increasing Duration)

Historically, during the reversal of an inverted yield curve, short-term yields fall faster than long-term yields. However, investors should be aware that the price appreciation on short-term bonds may be impacted by lower interest rate sensitivity, while longer-duration bonds are expected to achieve much larger price gains.

However, in the current economic environment, marked by concerns about inflation and uncertainty around the timing of the Fed’s potential pivot, flexibility is an important tool.

Barbell strategies that allocate to both short-term and long-term maturity municipal bonds help investors mitigate interest-rate risk, particularly in volatile rate markets, as short-term and long-term bonds often presents negative correlation. Additionally, this approach helps temper reinvestment risk by securing yields for an extended period.

The table below illustrates the potential outcomes of implementing a barbell strategy using a suite of our investment-grade municipal ETFs. This strategy entails equal allocations to short and long muni ETFs, such as the VanEck Short Muni ETF (SMB) and the VanEck Long Muni ETF (MLN). Despite offering nearly identical duration exposure compared to the broad muni index, the barbell strategy provides an additional yield pickup. Furthermore, the flexibility of the barbell strategy allows for quick adjustments to allocation between long and short exposures in response to changes in market conditions related to interest rates.

Outcomes of the Barbell Strategy: More Yield, Same Duration
DTW YTW TEY (32% tax rate) 5-year Treasury Yield Yield Pickup vs. Treasury
50% Short (SMB) & 50% Long (MLN) 5.47 3.55% 5.22% 4.24% 98 bps
ICE Broad Municipal Index (MUNI) 5.40 3.47% 5.10% 4.24% 86 bps

Source: ICE Muni Indices, as of 2/29/2024. Index performance is not illustrative of fund performance. It is not possible to invest directly in an index.

Enhancing Portfolio Yield: Leveraging Intermediate Municipal ETF with a Roll-Down Approach

Parallel to the barbell strategy, the roll-down strategy focuses on the intermediate portion of the municipal bond curve, which has recently re-steepened. This reconfiguration presents an opportunity to take on some modest duration risk and gradually shift allocation from money-market investments to VanEck’s Intermediate Muni ETF (ITM).

ITM specifically focuses on bonds with maturities ranging from 6 to 17 years (highlighted in the shaded region in the chart below). This strategy aims to enhance overall yield by capturing additional roll-down return from the steepest part of the curve, in addition to the current yield. As of the end of January 2024, close to 60% of ITM is allocated in the 10-15 year maturity range, which we consider to be the sweet spot on the curve, as the 10s/15s spread has widened the most compared to other parts of the curve.

Going Where the Yield Is: ITM Focuses on the Belly of the Muni Curve

Muni AAA Yield Curve

ITM Focuses on the Belly of the Muni Curve

Source: Bloomberg BVAL AAA muni curve, as of 2/29/2024.

As investors navigate the uncertainties of the current economic and monetary policy environment, the strategic use of barbell and roll-down strategies in municipal bond portfolios offers a nuanced approach to maximizing potential yield advantages while managing the risks associated with interest rate volatility. These strategies provide a comprehensive framework for investors looking to optimize their portfolios in anticipation of the Federal Reserve’s potential policy adjustments and the yield curve’s eventual normalization.

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This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities, financial instruments or digital assets mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, tax advice, or any call to action. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results, are for illustrative purposes only, are valid as of the date of this communication, and are subject to change without notice. Actual future performance of any assets or industries mentioned is unknown. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. VanEck does not guarantee the accuracy of third party data. The information herein represents the opinion of the author(s), but not necessarily those of VanEck or its other employees.

Bloomberg BVAL AAA Municipal Curve tracks movement in the municipal bond market.

ICE Board Municipal Index (MUNI) tracks the performance of investment grade tax-exempt municipal bonds.

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).

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 Please read the prospectus and summary prospectus carefully before investing.

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Originally published 25 March 2024. 

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