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Letter to Shareholders: December 31, 2022


Dear Shareholder:

An aggressive interest rate tightening campaign by the Federal Reserve (“Fed”) and persistent inflation led to a challenging fixed-income market in 2022. Investment grade municipal bonds posted a loss of -8.53% for the 12-month period according to Bloomberg index data, the worst annual performance since the early 1980s. The year was unsettling to investors who value municipal bonds for their safety and stability.

As bad as this year’s performance might seem, it is worth noting that municipal bonds outperformed most other fixed-income asset classes including U.S. Treasuries, investment grade corporate bonds, and even high yield corporate bonds. There is no denying that 2022 was a tough year for the municipal bond market; however, on a comparative basis, municipal bonds held up relatively well in what was a punishing market.

The Fed raised the fed funds target rate a total of 425 basis points during the year. The Fed last met on December 14 and raised the fed funds target rate by 50 basis points to its current level of 4.25-4.50%. The December meeting was notable because the Fed trimmed its rate hike to 50 basis points from previous rate hikes of 75 basis points. The Fed also reiterated its commitment to lowering inflation to 2% and tightening further. Most economists are forecasting at least another 100 basis points in rate hikes before the Fed pauses.

For the municipal bond market, 2022 was all about “normalization” which meant higher yields and lower bond prices. Due to the inverse relationship between bond yields and prices, municipal bond valuations declined significantly in response to a surge in municipal bond yields.

With 2022 now in the rearview mirror, the focus naturally turns to the question of what next year might have in store for the municipal bond market. We have always doubted the wisdom of so-called financial “experts” trying to make annual market predictions. We instead subscribe to the view that following a consistent, disciplined investing process will invariably lead to better outcomes than trusting the predictions of financial experts. As portfolio managers, we plan on adhering to that process in the coming year and thought it might be useful to briefly mention a couple of factors that we think may have the greatest impact on the municipal bond market next year.

Municipal bond returns during the past ten years have been negative just twice—the first time was in 2013 which coincided with the Fed’s “taper tantrum,” and the second time was in 2022. This steady history of delivering mostly positive returns (even in a decade long low-yield environment) is a testament to the power of the “income” component of bonds. The income component of fixed-income returns accounts for close to 90% of returns for periods as short as five years. With current yields resetting at higher and more attractive levels, the case for owning high quality municipal bonds as part of an overall investment portfolio has become even stronger. While the “normalization” process currently underway has been painful in the short-run, long-term fixed-income investors should view higher yields as a gift. Historically, fixed-income investors who have stayed the course through the ups and downs in the market have almost always been rewarded for their patience with higher absolute returns.

Municipal bonds have demonstrated a tremendous amount of resiliency both after periods of market declines and after the Fed finishes an interest rate tightening cycle. Municipal bonds have posted positive total returns in the 12 months immediately following market declines for the past 30 years. Additionally, following the last interest rate hikes of the previous seven Fed tightening cycles (going back to 1984), municipal bonds have provided consistent positive performance in the subsequent six-month, one-, three-, and five-year time periods. While past performance doesn’t necessarily guarantee future performance, this strong track record suggests that municipal bonds may rebound in the coming year.

The possibility of the economy tipping into a recession looks increasingly likely. Fortunately, the fiscal health of state and local governments continues to be very strong. Overall, a combination of factors including, but not limited to, the approaching end to the Fed’s tightening cycle, moderating inflation, higher yields, strong credit fundamentals, and improved investor sentiment should serve as catalysts for the municipal bond market next year. We are cautiously optimistic about the prospects for municipal bonds in 2023

Capital Gains Distributions:

Capital gains distributions were made in two of our Funds this year: (i) the Alabama Tax-Free Income Series and (ii) the Mississippi Tax-Free Income Series. Capital gains distributions were made on December 15, 2022—separate from and prior to end-of-year dividends. These capital gains distributions, along with all transactions made in your accounts in 2022, will be reflected on your end-of-year statements.

Thank you for investing with us. Happy New Year!




Allen E. Grimes, Ill President


2022 Capital Gains Distributions

In 2022, capital gains distributions will be made in two of our funds: (i) the Mississippi Tax-Free Income Series and (ii) the Alabama Tax-Free Income Series. For additional information on 2022 capital gains distributions, please see Dupree’s 2022 Dividend Factor and Capital Gain Information Page.

If you need assistance or have any questions, please call Dupree Mutual Funds at 1-800-866-0614, Monday through Friday between 9:00 A.M. and 5:00 P.M, Eastern Time.

Letter to Shareholders: September 30, 2022


Dear Shareholder:

After getting off to a good start in July, performance in the municipal bond market turned decidedly negative for most of August and September. Yields on benchmark 10-year and 30-year AAA-rated municipal bonds increased approximately 58 and 72 basis points, respectively, during the third quarter. Municipal bond yields have increased (prices down) to a level last seen in 2013.

The recent spike in market volatility has been fueled in large part by the Federal Reserve (“Fed”) which has ramped up its anti-inflation rhetoric and renewed its commitment to continue raising short-term interest rates. The Fed’s “hawkish” tone led to a strong risk-off sentiment in markets and to a broad selloff in all asset classes. For the 9-month period ended September 30, 2022, the Bloomberg Municipal Bond Index provided a total return of -12.13%. The last time municipal bond returns were this poor was in the early 1980s.

On a slightly more positive note, it is worth noting that municipal bonds have outperformed other fixed-income classes such as U.S. investment grade corporate bonds (-18.72% YTD) and U.S. Treasuries (-13.09% YTD). Equities have sold off sharply this year with the S&P 500 and Nasdaq 100 providing total returns of -24.77% and -32.40%, respectively.

Federal Reserve Update:

The Fed raised the fed funds rate by an additional 75 basis points to 3 – 3.25% at its meeting in mid-September. The Fed increased its median fed funds rate estimates for this year and next year signaling that they now expect a fed funds terminal rate in the range of 4.5 – 4.75%. The Fed acknowledged that it would take some time to get inflation back down to desired levels. The Fed sees inflation gradually declining to a level of around 2.9% by 2025. The Fed’s preferred inflation gauge, the core personal consumption expenditures index, increased at an annual rate of 4.9% in August which was up slightly from the previous month.

The Fed has two remaining meetings this year, one in early November and the other in mid-December. The market currently expects that the Fed will raise the fed funds rate at each of these meetings, with most Fed followers expecting 50 or 75 basis point rate hikes. With an active Fed determined to get inflation back in check, it seems likely that markets will continue to experience higher than normal levels of volatility for the remainder of this year.

Against this backdrop, investors are increasingly concerned about the potential for a prolonged economic downturn or even a recession. Economists and market strategists have raised the odds of a recession, and the market seems to be coming to terms with the idea that a recession is probably unavoidable. With a “hard landing” scenario increasingly likely, we thought it might be worthwhile to briefly mention a couple of points that may provide some comfort to long-term municipal bond investors.

Historically, tax-exempt bonds have performed relatively well during recessionary periods. Municipal bond credits are very resilient in uncertain times due to a combination of unique factors including, but not limited to, the following: strong reserves and revenue pledges, the ability of municipal issuers to adjust budgets, and an issuer’s ability to raise taxes, if necessary, to cover required debt service payments. State and local government balance sheets are currently flush with cash thanks to a combination of unprecedented federal assistance and a strong rebound in general fund tax revenue collections. One irony of inflation is that while it’s bad for working Americans, it’s great for government coffers as nominal profits and incomes rise.

Municipal bond credit rating upgrades are currently outpacing downgrades by a wide margin. Municipal bond defaults continue to be very rare events representing just a tiny fraction of the overall market. Only $2.1 billion par value defaulted in 2021, which represented only 0.05% of the $4 trillion municipal market. (Source: Bank of America/Merrill Lynch Research). The vast majority of municipal defaults has been confined to various sectors in the high yield space (e.g., long-term care, charter schools, and land-secured bonds).

The idea of investing in fixed-income during periods of high inflation and rising interest rates can seem counterintuitive. However, thinking and acting rationally in what are often emotion-driven markets requires patience and perspective. From our perspective as fixed-income investment managers, we believe today’s higher municipal yields potentially offer an attractive entry point for new investors or existing investors that have a reasonably long investment time horizon. Valuations in the municipal bond market have improved dramatically, and our portfolio managers are busy adding high quality bonds to our various investment portfolios at very attractive levels. Higher yields offer more of a cushion for total returns over time, even if price movements remain volatile. Instead of trying to time the market, most investors who have stayed the course through past Fed tightening cycles have been rewarded for their patience with higher total returns over the long run.

On the other hand, if you are a risk averse investor with a short investment time horizon, we would be the first to admit that the current market can be treacherous. If you fall into this category, don’t let anybody fool you into thinking that cash isn’t a legitimate asset class.

Before closing, I want to take moment to remember Terry Moore, our receptionist of 17 years who passed away in August. Terry was unfailingly cheerful, kind, and always willing to go the extra mile. We remember her with gratitude as we keep her husband and children in our thoughts.

Thank you for the continued confidence that you have placed in us.




Allen E. Grimes, Ill President


Annual Report – June 30, 2022


A copy of the Dupree Mutual Funds Annual Report dated June 30, 2022 is available here.

Letter to Shareholders: June 30, 2022


Dear Shareholder:

We’re at the midway point of the year, and financial markets are continuing to grapple with an aggressive Fed and inflation that continues to run hot. Municipal bonds performed better in the second quarter than in the first quarter; but, yields continued to adjust upwards, and bond prices declined. Notwithstanding the disappointing start to the year, we are optimistic that municipal bonds will perform better during the second half of this year.

Before turning to why we think the municipal bond market will improve in the second half of 2022, it’s worth repeating why higher interest rates benefit long-term bond investors. In fact, for investors with a reasonably long investment time horizon, rising rates are something to cheer, not fear. When interest rates rise, new bonds pay a higher coupon, increasing the income investors receive. Because interest income is the primary driver of bond returns, the ability to reinvest into a rising rate environment can help investors build long-term growth. Even over relatively short periods of time, rising income may provide a return advantage for fixed-income investors.

The yields of our funds are expected to rise gradually as we purchase new bonds issued at higher rates. Since the beginning of this year, yields on benchmark 10-year and 30-year AAA-rated municipal bonds have increased nearly 170 basis points. The sharp increase in yields provides us an opportunity to build higher and more durable income streams. For example, we recently purchased a number of high quality municipal bonds in the primary market for several of our tax-exempt funds with yields approaching 4.00% and in one case 4.50%. Higher yields have restored a lot of value to the municipal bond sector which we believe was oversold.

In the past few weeks, bond markets have rallied as financial markets have priced in a much higher chance of a recession. This repricing followed the Fed’s 75 basis point June rate hike and subsequent comments by Fed Chairman Powell acknowledging that steep rate hikes could potentially trigger a U.S. recession. Bond traders have begun pricing in a shallower rate path with fewer interest rate hikes and even a possibility that the Fed will be forced to change course and start cutting interest rates sometime in 2023. The “hard landing” or recession narrative has picked up considerable momentum and has dramatically improved market sentiment towards bonds, while at same time raising additional concerns about current equity market valuations.

Tax-exempt investors can take some comfort in knowing that municipal bonds have generally performed relatively well during recessions. Total returns for municipal bonds have been largely positive during recessions, with two negative episodes in 1981 and 2008. However, each of those periods was followed by a solid rebound. It is also worth noting that municipal bonds tend to outperform other fixed-income assets such as U.S. Treasuries and corporate bonds during Fed tightening cycles.

Credit fundamentals for state and local debt are very strong. General fund revenue collections across the states are robust with most states reporting large revenue surpluses and growing rainy day fund reserves. Credit rating upgrades currently exceed downgrades by a three-to-one margin. With the broad bond market selloff, there appears to be a growing disconnect between municipal bond prices and healthy government balance sheets. Ultimately, strong credit fundamentals should help support municipal bond prices for the remainder of this year, especially in a slow growth or recessionary environment where credit quality becomes of paramount importance.

In the near term, the municipal bond market will likely get a boost as principal and interest payments coming due in June, July, and August are reinvested. Bloomberg estimates that approximately $123 billion will be returned to investors from maturing municipal bonds during this 3-month period. This sizeable reinvestment activity should coincide with a relatively light supply of new bonds as a combination of large amounts of federal aid and strong tax collections has reduced the need for many states and cities to sell debt. These favorable supply-and-demand dynamics should act as a tailwind for the municipal bond sector.

It’s no secret that inflation has recently hit new highs. The big unresolved question is how long high inflation will last? The Fed’s preferred inflation gauge, the core PCE, increased at an annual rate of 4.7% in May which is down from a high of 5.3%. Many economists believe there is a good chance that core inflation will continue to decline through the summer especially if, as expected, consumer spending continues to cool, retailers put excess inventories on sale, and supply chain bottlenecks improve. In addition to monitoring core prices, the Fed also keeps a close eye on inflation expectations because they can feed future inflation. While still relatively high, long-term (5-10 years) consumer inflation expectations are also starting to show signs of trending lower which is a positive development for bond markets.

Unlike the Treasury and corporate bond markets which are controlled by institutional investors, the municipal bond market is dominated by retail investors. This makes municipal bond prices more susceptible to investor flow cycles. Municipal bonds have been in a prolonged outflow cycle as investors react to rising interest rates and elevated inflation. As uncertainty around the Fed’s monetary policy path dissipates further and inflation numbers continue to moderate, the outflow cycle will inevitably come to an end and may ultimately reverse itself.

While additional volatility is always a possibility, we are convinced that better times lie ahead for the municipal bond market. We’re confident that today’s cheaper municipal bond valuations present an attractive entry point for long-term fixed-income investors.

Thank you for the continued confidence that you have placed in us. Enjoy your summer!




Allen E. Grimes, Ill President


Letter to Shareholders: March 31, 2022


Dear Shareholder:

After experiencing record-setting inflows and posting solid returns in 2021, the municipal bond market is off to a rocky start this year. Flows into municipal bond funds turned negative, and Treasury and municipal bond yields surged (valuations have declined) as market expectations reset to reflect ongoing fears about persistently high inflation readings, the outbreak of war in Ukraine, and a pivot to a more aggressive monetary policy stance by the Federal Reserve Open Market Committee (FOMC).

The abrupt and unexpected change in market sentiment and the resulting sell-off in the municipal bond market surprised many, including us. In addition to the factors mentioned above, less favorable supply and demand dynamics (i.e., a higher supply of tax-exempt bonds coupled with less demand) also contributed to falling bond prices. This combination of factors and events led to a perfect storm: the municipal bond market suffered one of its worst quarterly losses on record during the first quarter. The Bloomberg Municipal Bond Index provided a -6.23% total return for the 3-month period ended March 31.

Federal Reserve Update

The FOMC raised the fed funds rate by a quarter percentage point to a target range of 0.25% to 0.50% after its mid-March meeting. It also strongly hinted that additional rate hikes will follow at each of its six remaining meetings this year. Elevated inflation, mainly reflecting supply and demand imbalances related to the pandemic and higher energy prices, was the main reason given for adopting a tighter monetary policy stance.

The FOMC released a new economic forecast and dot plot which provide information about the expected path of the fed funds rate. The FOMC anticipates weaker GDP growth this year, and it now expects to raise the fed funds rate a total of ten times (six hikes in 2022 and four hikes in 2023). That means that the terminal fed funds rate range will probably be somewhere between 2.75% and 3.00%. The FOMC also raised its near-term median forecasts for core PCE inflation to reflect the recent increase in prices.

In addition to raising the fed funds rate, the FOMC also indicated that it would start reducing its balance sheet holdings, which consist of Treasury securities, agency debt, and agency mortgage-backed securities. No precise timeline was announced for starting the balance sheet reduction process, but it could potentially start as early as May. Instead of purchasing more securities or replacing securities coming due, the FOMC will simply let securities roll off organically as the debt matures. With approximately 25% of the balance sheet maturing within two and a half years, the FOMC should effectively be able to reduce the size of its balance sheet without having to resort to any open market asset sales.

The Income Component of Fixed-Income Returns

Make no mistake, the volatility and downward price action in the municipal bond market have been gut wrenching. As human beings, our natural tendency is to react emotionally to market sell-offs which almost always leads to poor investment decisions. With bond yields still relatively low and the FOMC embarking on an interest rate hiking cycle, fixed-income investors are understandably a bit anxious and nervous.

Benjamin Graham, known as the father of value investing, believed the key to investment success—in both equity and bond markets—is having the temperament to keep emotions in check and remain focused on long-term results. In his book, The Intelligent Investor, Graham wrote, “For indeed, the investor’s chief problem—and even his worst enemy—is likely to be himself.”

In volatile markets with falling bond prices, investors sometimes forget that the income component of fixed-income investments typically accounts for over 90% of total returns for periods as short as five years. If you are an investor with a reasonably long investment time horizon, it isn’t rational to focus on bond prices alone when the vast majority of the total return of bonds is generated by the income component. While the share prices of all our single-state municipal bond funds have declined recently, each of these funds continues to generate a steady stream of tax-free income that can be counted on, regardless of share price.

Interest rates have remained at historically low levels for close to a decade which has caused the prices of bonds to remain artificially elevated. With yield normalization, bond prices will be returning to more historic levels, and investors will be earning higher yields as new bonds are issued at higher interest rates. In a rising interest rate environment, when it’s time to reinvest bond proceeds from coupon payments, calls, and/or maturities, changes in interest rates do matter. As rates rise an investor can reinvest at higher yields. If an investor has a multi-year investment time horizon, this reinvestment effect means that the investor should ultimately be better off. So, please keep in mind that with rising interest rates long-term bond investors have little to fear and even, potentially, something to gain.

The shift to a buyer’s market from a seller’s market happened quickly and without much warning. From our perspective as portfolio managers, sell-offs like we experienced during the first quarter of this year present great opportunities to find value and build higher and more durable income streams for investors. Rest assured, we are staying busy trying to do just that.

Thank you for the confidence you have placed in us.




Allen E. Grimes, Ill President


Letter to Shareholders: December 31, 2021


Dear Shareholder:

It’s hard to believe, but two years after first emerging the pandemic shows no signs of abating with the omicron variant spreading rapidly across the world and pushing COVID-19 infections to record levels. Our hearts go out to everyone that has been affected by the ongoing public health crisis, and we continue to be grateful for the heroic and valiant efforts of our front-line healthcare workers. We are also keeping our shareholders that may have been impacted by the recent tornadoes in western Kentucky, Tennessee, and Mississippi in our thoughts and prayers.

Municipal Market Update

While 2021 was another tough year in many respects, the municipal bond market managed to turn in a positive performance for the year. For the 12-month period ended December 31, the Bloomberg Municipal Bond Index provided a total return (which includes price changes and interest payments) of 1.52 percent. Municipal bonds outperformed other fixed-income assets such as U.S. Treasuries and investment grade corporates, both of which delivered negative total returns for the year.

The municipal market’s steady performance was fueled by a combination of favorable supply and demand dynamics (i.e., limited supply combined with strong demand), improving credit fundamentals, and passage by Congress late in the year of the $550 billion infrastructure package. Solid tax revenues and unprecedented federal support have helped state and local governments weather the pandemic much better than anticipated. Municipal credit upgrades have outnumbered downgrades this year. Improving credit quality has led to strong inflows into municipal bond mutual funds and exchange-traded funds. While the number of municipal bond defaults has ticked up slightly, defaults remain concentrated almost entirely in the high yield space led by nursing homes, industrial revenue bonds, and charter schools.

Trying to predict future market performance is always hazardous, especially in the middle of a pandemic. Nonetheless, we think a couple of factors will help support the municipal bond market in the coming year.

Credit quality in the investment grade municipal bond market is currently stronger than ever. State and local governments are flush with cash thanks in large part to COVID-19 relief. State and local tax revenues have soared as nominal profits and incomes have risen. Property, corporate, sales, and individual tax revenues have all risen sharply thanks to a strong economic recovery, a frothy stock market, a strong housing market, and ongoing federal assistance. That, coupled with the fact that U.S. municipalities are set for another large multi-year infusion of cash from the infrastructure package, has led many to conclude that municipal bonds may be set for a “golden decade” of credit ahead. The credit quality of each of our Funds is very strong, and we believe that the credit quality will remain strong in light of these factors.

Seasonal factors should also help support the municipal bond market as we start the new year. Historically, the “January Effect” has been supportive of municipal bond performance as reinvestment income from maturities, calls, and coupons significantly outpaces new supply. Continued strong demand, coupled with a net negative supply of municipal bonds, will likely help the municipal bond market get off to a strong start next year and should act as a floor for any potential price declines.

One slightly technical observation and potentially bullish development is also worth noting. Recently, the strong historic correlation between municipal bonds and U.S. Treasuries has weakened. As this year’s performance demonstrated, municipal bonds simply are not tracking U.S. Treasuries the way they used to. One plausible explanation for the decoupling is that the municipal bond buyer base is increasingly comprised of small retail buy-and-hold investors, as opposed to institutional investors which dominate the Treasury market. This “stickier” buyer base has resulted in less volatility for municipal bonds. If this trend continues, it potentially has implications for next year as the weaker correlation makes municipal bonds more attractive as a potential hedge against rising Treasury yields.

Federal Reserve Update

The Federal Open Market Committee (FOMC) met on December 15 and left the federal funds rate unchanged at 0 to ¼ percent. In response to persistently elevated inflation readings, it decided to double the pace of its quantitative easing taper which it first announced in November. The taper should be complete by as early as March. The FOMC’s statement was notable because it abandoned the term “transitory” that it had previously used to describe inflationary pressures which remain stubbornly high. The guidance on interest rate hikes also changed and is now weighted more towards labor market conditions (i.e., future assessments of maximum employment) rather than price stability. Overall, there were no huge surprises. The FOMC is still expected to raise interest rates by the same amount, but interest rate hikes are now expected to start sooner than originally anticipated.

Capital Gain Distributions

Capital gains distributions were made in four of our Funds this year: (i) the Kentucky Tax-Free Income Series, (ii) the Mississippi Tax-Free Income Series, (iii) the North Carolina Tax-Free Short-to-Medium Series, and (iv) the Alabama Tax-Free Income Series. Capital gains distributions were made on December 16, 2021—separate from and prior to end-of-year dividends. These capital gains distributions, along with all transactions made in your accounts in 2021, will be reflected on your end-of-year statements.

Thank you for investing with us. Happy New Year!




Allen E. Grimes, Ill President


2021 Capital Gains Distributions

In 2021, capital gains distributions will be made in four of our funds: (i) the Kentucky Tax-Free Income Series, (ii) the Mississippi Tax-Free Income Series, (iii) the North Carolina Tax-Free Short-to-Medium Series, and (iv) the Alabama Tax-Free Income Series. For additional information on 2021 capital gains distributions, please see Dupree’s 2021 Daily Dividend Factor Information Page.

If you need assistance or have any questions, please call Dupree Mutual Funds at 1-800-866-0614, Monday through Friday between 9:00 A.M. and 5:00 P.M, Eastern Time.

Letter to Shareholders: September 30, 2021


Dear Shareholder:

The third quarter was, for the most part, a quiet and uneventful one for the municipal bond market. It was “quiet” because trading volumes and measures of market volatility for the municipal bond market hit new lows. Investors are hanging on to the municipal bonds in their portfolios and also snapping up new issues at a record pace. It was “uneventful” because (with the exception of a small spike in yields at the end of the quarter) municipal bond yields and prices remained range-bound. The Bloomberg Barclays Municipal Bond Index has provided a year to date total return of 0.79%.

The Federal Reserve Open Market Committee (”FOMC”) wrapped up its two-day meeting on September 22. The FOMC kept the fed funds target range unchanged at 0 to 0.25%. One of the main takeaways from the meeting was a signal that the FOMC is close to starting the “tapering” process of winding down its asset purchases. The FOMC will likely announce the start of the taper at its November meeting. Nobody really knows how long the taper will last. However, it is worth noting that the 2008 taper lasted approximately 14 months and the 2014 taper lasted approximately 10 months. Chair Powell has suggested that the taper could potentially be complete by mid-2022.

Regardless of how long it lasts, it’s critical to understand that tapering is not the same thing as tightening. To the contrary, monetary policy will continue to be accommodative as the FOMC’s balance sheet will continue to grow, albeit at a slightly slower pace. Economists estimate that the FOMC’s balance sheet will exceed $8.5 trillion at the end of the taper process, which is roughly double the size that it was two years ago. Moreover, the FOMC’s balance sheet is expected to stay at elevated levels for the foreseeable future.

After the official taper announcement, the focus will then shift to a discussion of the anticipated date of “liftoff” and the future path of the fed funds rate. The FOMC did update its “dot plot” at the September meeting, and several participants pulled forward their assessments of when the first interest rate hike would likely occur (9 of 18 participants now see a first interest rate hike in 2022 versus 7 in June). Nine FOMC participants also expect that the fed funds target rate will be above 1% by the end of 2023. The upward revisions were relatively minor and make sense given that recent elevated inflation readings have been more persistent than originally anticipated.

Discussing the nuances of the taper and trying to predict the date of liftoff are probably best left to economists and strategists. Instead, we think a couple of key points are worth considering as we move a bit closer to the start of a Fed tightening cycle. First, even though on the surface it may sound counterintuitive, interest rate increases are not a bad thing for fixed-income investors. Changes in interest rates matter when it’s time to reinvest proceeds from coupon payments, called bonds, or bonds that have matured. Rising interest rates allow a fixed-income investor to reinvest at higher yields. This is the exact opposite of “financial repression” which is the term used to describe market conditions that have prevailed for the past decade or so where investors have been forced to accept lower yields that are available in the market at the time of reinvestment. As market yields normalize over time, the yields of our funds will also start gradually increasing as we purchase new bonds issued at higher coupon rates.

Make no mistake, what can be bad for short-term fixed-income investors are sudden and large increases in interest rates. The FOMC has been talking about the taper since last December, and it has been very transparent about the criteria that must be met before a first interest rate hike occurs (i.e., maximum employment and inflation that runs above 2.0% for some time). To its credit, the FOMC has devoted a significant amount of time and resources in recent years to improving its transparency and communications. We don’t think the FOMC will want to jeopardize its hard work and credibility by surprising markets with any sudden or larger than anticipated interest rate hikes.

We continue to believe that the tightening cycle will be a gradual and shallow one. The economy continues to face numerous challenges and uncertainties, including significant supply-chain bottlenecks. This, combined with the fact that the starting point for the tightening cycle is near zero, strongly suggests that the fed funds terminal rate (the rate that exists at the end of the tightening cycle) will be substantially lower than it has been in previous tightening cycles.

Some nervous investors might be tempted to sell their bonds in anticipation of rising yields with the idea of buying them back once they cheapen up. We think it’s worth briefly reminding folks that timing the market is almost always a losing proposition. Moving to cash instruments yielding near 0% carries with it a large opportunity cost, especially if yields don’t rise as soon or as much as expected. Reallocating from bonds to stocks when stock market indices are near all-time highs is an even riskier proposition. The upshot is that if you are an investor with a multi-year investment time horizon, there’s really no good reason to fear yield normalization–it’s actually a positive long-term development.

It should be noted that Congress is still busy negotiating the passage of an infrastructure bill and much larger reconciliation bill. The details of the reconciliation bill are changing on a daily basis. Passage of an infrastructure bill will likely have a net positive impact on the municipal bond market. Among other things, higher individual and corporate income tax rates will make holding tax-exempt municipal bonds even more attractive for retail and institutional investors. Higher corporate tax rates should result in increased demand for tax-exempt municipal bonds by banks and property and casualty insurers, both of which significantly reduced their purchases after the 2017 tax reform. With higher tax rates on the horizon, we think it’s more important than ever to have a portion of your overall investment portfolio invested in high quality tax-exempt bonds.

Thank you for your continued trust and support.




Allen E. Grimes, Ill President

Letter to Shareholders: June 30, 2021


Dear Shareholder:

Municipal bonds turned in a mixed performance during the first half of this year. While the first quarter witnessed an unexpected surge in Treasury yields that led to some volatility in municipal bond prices, municipal bonds then proceeded to post positive total returns each month during the second quarter. For the six-month period ended June 30, the Bloomberg Barclay Municipal Bond Index provided a total return of 1.06%.

Favorable supply and demand dynamics, a steady interest rate environment, and improving credit fundamentals all contributed to the steady performance of the municipal bond market. Summertime has historically been a period of strong performance for municipal bonds as reinvestment flows typically outpace new municipal bond issuance. This summer looks to be no different. Bloomberg estimates that $165 billion will be returned to bondholders (due to maturing bonds and interest payments) for reinvestment into the market, which is roughly $45 billion more than what is expected to come to market via new issuance. This “net negative supply” environment should keep bond prices firm in the near-term, especially with continued strong demand for tax-exempt investments.

The macroeconomic outlook continues to improve. Economic growth has strengthened considerably in recent months with real gross domestic product (GDP) increasing at an annual rate of 6.4% during the first quarter of 2021. This rapid growth reflects the continued bounce back in activity from depressed levels as large areas of the country emerge from the pandemic. Consumer spending for goods and services, which accounts for roughly two thirds of the U.S. economy, is increasing at a rapid pace, and the housing market is very strong. The labor market has also strengthened with the unemployment rate in May standing at 5.8%.

The vast majority of states and cities have emerged from Covid-19 with better than expected revenues. Against this backdrop and flush with federal stimulus dollars, governors and mayors across the country are pushing for large increases in spending. According to data compiled by the National Association of State Budget Officers, total general fund spending proposals rose approximately 5% to $963.6 billion for fiscal year 2022, with 39 states forecasting spending increases. At the federal level, Congress is currently debating passage of additional wide-ranging fiscal policy measures to shore up the economy and social welfare programs. All of this is occurring at a time when the Federal Reserve Board (the “Fed”) continues to maintain an accommodative monetary policy.

Not surprisingly, this confluence of events has raised concerns about the potential for an outbreak of inflation. To be sure, inflation readings have increased notably in recent months. The Fed’s preferred inflation measure, the core Personal Consumption Expenditures Index, increased at an annual rate of 3.4% in May (up from 3.1% in April). This rate exceeds the Federal Reserve’s 2% longer-run inflation goal. However, there is an intense ongoing debate about whether the recent increase in prices will be “transitory” in nature as the Fed sees it, or “sticky” as others believe will be the case.

In testimony before Congress, Fed Chair Powell noted that the recent increase in inflation likely reflects four main factors: (1) base effects (i.e., comparisons with the low prices during the Covid-19 shutdown); (2) a rebound in spending as the economy reopens; (3) pass through of past increases in oil prices to energy prices; and, (4) supply bottlenecks which have limited how quickly production in some sectors can respond in the near term. Other Fed officials have also noted that large outliers such as skyrocketing used car and truck prices (+7.3% in May), car and truck rental prices (+12.1% in May), and airfares (+7.3% in May) have accounted for a significant portion of the price increases and are likely to revert to a level closer to the Fed’s longer-run target as demand cools and these transitory supply effects abate.

The counterargument to the Federal Reserve’s position is that some elements of consumer prices have exhibited signs of more sustained price increases. For example, housing prices have moved up sharply in recent months and have showed no signs of cooling. A shortage of semiconductors has also pushed up prices of consumer electronics and appliances. Some economists and investment professionals have also pointed out that the current administration’s focus on reducing wealth inequality and promoting clean energy may support a structural lift to inflation.

The market seems to be signaling that inflation will be transitory. The 5-year and 10-year breakeven inflation rates are currently at 2.51% and 2.35%, respectively. We tend to agree with those who believe that the parts of the economy that are contributing the most to inflation in recent months are merely “reflating” back to normal levels and will likely level off later this year or early next year. We certainly don’t think the temporary spike in prices will lead to runaway inflation.

The Fed has been purchasing $80 billion of Treasuries and $40 billion of mortgage-backed securities on a monthly basis since March 2020 to support the economy. The inflation debate has renewed attention on the issue of when the Federal Reserve will begin to start winding down its asset purchases (also known as “tapering”). The Fed indicated after its most recent meeting which was held in mid-June that it would continue its purchases at the same pace until “substantial further progress” is made on employment and inflation.

The timing and duration of the Fed’s tapering is important because it will likely dictate the timing of any future interest rate hikes. Most Fed watchers expect that the tapering process will be slow and gradual. After the 2008 financial crisis, tapering lasted approximately fourteen months. If history is any guide, and assuming that the Fed begins the process early next year, that would mean that the first interest rate hike could possibly come as early as the first quarter of 2023.

As always, thank you for investing with us. Enjoy your summer!




Allen E. Grimes, Ill President