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Why muni floating-rate notes may be attractive now

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The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance fund. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results.

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      By Adam A. Weigold, CFA, Senior Municipal Portfolio Manager, Eaton Vance Management

      Boston - Even though interest rates have leveled off a bit in recent months, we continue to believe that municipal floating-rate notes are offering relatively attractive yields with some protection against volatile equity and fixed-income markets.

      Muni floating-rate notes -- an often-overlooked part of the market -- may make sense for investors looking to take advantage of rising short term interest rates and a flattening yield curve. This is the case today because short-term rates have risen significantly since the Fed began its tightening campaign in December 2015. In other words, investors can stay on the short end of the curve (2 years or less) and still get much of the yield offered at the longer end of the curve, but with less duration risk.

      What are muni floating-rate notes?

      Muni floating-rate notes can offer attractive income and a way to potentially hedge against short-term interest-rate risk.

      As short-term rates rise, investors may potentially realize additional tax-advantaged income. While fixed-rate bonds could lose value when short rates rise, floating-rate instruments may help protect against rising rates because their duration is effectively zero.

      Like bank loans (also called leveraged loans), muni floating-rate notes have coupons that float, or reset, at periodic intervals. The coupons of muni floating-rate notes are tethered to short-term rates such as the weekly Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Index 1 or London Interbank Offered Rate (LIBOR). Both SIFMA and 1-month LIBOR have been moving higher lately (see the figure below), and could continue to rise if the Federal Reserve continues to hike its key short-term rate.

      Blog Image Sifma Libor Jan 30

      Fed and rates in focus

      Muni floating-rate notes typically pay yields that are based on SIFMA or a percentage of LIBOR plus a credit spread. Each coupon floats, or resets, at periodic intervals based on the movement of SIFMA or LIBOR. In that way, they are similar to bank loans.

      However, muni floating-rate notes are generally investment-grade securities, while leveraged loans are typically rated below investment grade. It's also important to remember that income from muni floating-rate notes is exempt from federal taxes; income from corporate bank loans or Treasury bonds is federally taxable.

      Though the January Fed statement removed explicit references to future rate hikes, floating-rate muni yields have already moved considerably higher from a few years ago when the Fed first started signaling a move away from the zero interest rates after the financial crisis.

      The Fed has hiked rates nine times over the last three years, from a starting point near zero. With the Fed apparently in the late stage of its hiking cycle, we believe now is the time to look at floating-rate munis.

      Bottom line: Muni floating-rate notes may be a way to earn attractive after-tax income with some protection from rising rates.