Dear Shareholder:
The municipal bond market experienced another tough year in 2024 with the Bloomberg Municipal Bond Index providing a 1.05% total return. Performance during the third quarter of the year was the bright spot with municipal bonds staging a strong rally in anticipation of the Fed’s first interest rate cut (50 bps) in September. However, the positive performance was short-lived and largely offset by an unexpected spike in bond yields (prices down) in December. The end result was a very modest positive total return for the year.
At its mid-December meeting, the Fed cut the fed funds rate by a quarter point to 4.25% – 4.50%. The Fed’s economic forecasts were mostly unchanged with one notable exception: its inflation outlook. Reflecting its view that taming inflation will take longer than expected, the Fed revised its 2025 inflation forecast upwards from 2.2% to 2.5%. The Fed also updated its dot plot and now expects only two interest rate cuts next year, rather than the four it had previously predicted. The Fed’s more cautious rhetoric and stance caught the bond market by surprise, and the market quickly responded with a sharp increase in yields and a corresponding drop in bond prices.
Although total returns finished almost flat for the year, the municipal bond market performed relatively efficiently in 2024. Total tax-exempt issuance in 2024 came in at just over $500 billion, which is close to a record. The surge in supply was fueled by a combination of dwindling pandemic aid, slowing tax collections, and rising infrastructure costs. The good news is that demand for tax-exempt bonds held up well with new bond deals frequently oversubscribed. We have been staying busy taking advantage of higher absolute yields by selling some of our lower yielding bonds and replacing them with higher coupon bonds, which over time will help increase the distribution yields of our funds.
While there are lots of variables and unknowns that could impact financial markets in the coming year, we believe the municipal bond market is well positioned to turn in a solid performance in 2025. The inflation outlook is definitely a wildcard (particularly with a new incoming administration), but inflation will eventually subside which should permit the Fed to further ease rates. While we don’t believe the fed funds rate will return to a near-zero level, we are confident that rates will eventually drop further. All other things being equal, this should act as a support for bond prices next year.
Tax legislation is certain to be a priority in the new year. With the election now over, it seems clear that many provisions of the TCJA will be extended. Now the hard and messy work begins to figure out how to pay for it!
As always, we appreciate the confidence that you have placed in us. Happy New Year!
Sincerely,
Allen E. Grimes, Ill President