The Barbell Strategy

The Fed has guided the markets toward lower rates, even if there are discrepancies over the timing of when such a move kicks off. That repricing, especially following pushback from Fed Chair Jerome Powell over an early rate cut, is primarily what’s driving recent volatility in bond markets.

An inversion remains on the US Treasury curve and by proxy the AAA municipal curve, yet its depth has pulled away from the worst levels. Though we are still removed from a "normal" curve shape, some consideration should be given to how portfolio dynamics will be affected when that time comes.

While waiting for those potential opportunities, we can still observe within the existing set of market conditions what might influence potential buyers of municipal bonds. We've broken out the muni yield curve into two tenors, 10 and 30 years. For buyers just interested in maximum yield/value, longer duration for munis appears the cheapest option and can be tackled in various ways.

Those more focused on total return -- and based on expectations for how the curve will steepen -- might be targeting longer-dated bonds with shorter calls, or barbelling a portfolio using shorter bullets, to try and ride the wave of changing Fed policy as the rest of the year plays out.


Source: Bloomberg, LP

A hypothetical barbell strategy could look something like the chart below. It includes tax-exempt bank qualified munis where the short duration portion of the barbell has a 7/1/2024 final maturity lowering interest rate risk over the short term, allowing the portfolio to be reinvested at a higher rate if the fed sticks to a “higher for longer” policy. Vice versa, in a falling rate environment the longer duration portion of the barbell will experience positive price performance, hedging against the reinvestment at lower rates when the shorter end of the portfolio matures. The third element in this strategy is the yield pickup when comparing against other bank qualified municipals with a ~3.5yr maturity.