Dear Shareholder:
It’s the halfway point of the year, and the municipal bond market has had to contend with a laundry list of challenges. Among those challenges are rising interest rates, inflation, tariff-induced uncertainty and volatility, escalating geopolitical conflicts, concerns about the growing US deficit, tax reform, a Fed that has adopted a wait-and-see approach on future interest rate cuts, elevated levels of supply, and the loss of the last “AAA” credit rating for US Treasuries. Despite all of this, municipal bonds finished the first six months of this year nearly flat, with the Bloomberg Municipal Bond Index providing a total return of -0.35%.
The Fed reaffirmed its wait-and-see policy stance at its meeting in mid-June, leaving the fed funds target rate unchanged at 4-1/4 to 4-1/2 percent. In support of its decision, the Fed cited the strong economy, concerns that tariffs might raise costs for consumers and producers, and the possibility that oil prices could spike because of the Middle East conflict. The Fed’s median forecast still calls for two interest rate cuts in 2025. In the meantime, the Trump administration is waging a public relations pressure campaign to try to persuade Chair Powell to cut interest rates now; but, the Fed has been content to hold rates steady until there is further clarity on the economic impacts of tariffs and ongoing geopolitical uncertainty.
Most market participants expect that the outlook for the municipal bond market will improve during the second half of this year. While volatility may remain elevated, supply and demand dynamics are set to improve during the summer months, which typically experience a higher number of bond maturities and increased reinvestment activity. As the municipal bond market transitions from a net positive to a net negative supply (new issue supply minus redemptions), bond prices should rise. On the demand side of the equation, higher yields have helped bring retail and institutional buyers back into the municipal bond market. From a credit quality perspective, upgrades continue to exceed downgrades.
We are taking advantage of the higher yield environment which currently offers very attractive valuations. We have been busy selling some of our lower yielding, lower coupon bonds that we purchased when rates were close to zero and replacing them with higher yielding, higher coupon bonds. Over time, this will have the effect of increasing the distribution yields of our funds. As we always do, we are being extra careful with our securities selection, primarily buying essential service bonds and avoiding riskier sectors.
I wanted to take this opportunity to welcome Story Miller as a new member of the Dupree team. Story recently graduated from the University of Kentucky with degrees in finance and economics. We are pleased to be working with Story, and I am confident that you will enjoy getting to know him over the coming years.
Thank you for investing with us. I hope you enjoy your summer!
Sincerely,
Allen E. Grimes, Ill President