Municipal bond yields over the course of U.S. history have reflected fluctuating rates of inflation, changing tax policies and the Federal Reserve’s monetary policy.
In the early and mid-19th century, high-grade long-term municipal bond yields were generally a bit more than 5%. Economic historians Sidney Homer and Richard Sylla found this rate to be the norm by studying yields on bonds traded in New England during that period.
In their book, “A History of Interest Rates,” they determined that yields started to slide around 1875, and by 1900 the highest-grade munis offered just 3%.
The Bond Buyer started compiling its 20-Bond Index in 1900. The index shows that from 1900 yields slowly rose from 3% to about 5% by 1920 (see graph on front page). Other than a brief jump in the mid-1930s, bond yields would subsequently decline until 1946.
On Feb. 14, 1946, The 20-Bond Index reached its all-time low of 1.29%.
In 1946, “the best long municipal bonds sold to yield less than 1%,” Homer and Sylla state in their book.
Following this trough, bond yields would generally go up for the next 35 years but until the mid-1960s the increase was moderate. Bond yields were low from the mid-1930s to the mid-1960s for two reasons, according to Sylla.
“In general, the trend of all interest rates and yields was down from around 1920 to the late 1940s — in part because the U.S. Treasury had the Federal Reserve peg interest rates on U.S. debt at low levels for the decade 1941-1951 to keep World War II financing costs low — and then market yields rose on gradually from the late 1940s to the mid ’60s,” Sylla said.
“More specifically pertaining to munis, they were tax-exempt for federal income tax purposes, and the marginal rates of income taxation went to lofty levels during World War II and then stayed there into the mid 1960s; the higher the federal marginal tax rate, the more valuable the muni tax exemption, so high earners piled into munis, driving down their yields.”
Municipal bond yields generally continued to rise through the 1970s — a period characterized by high inflation — until peaking early in 1982. The Bond Buyer 20-Bond Index reached its all-time high of 13.44% on Jan. 14, 1982. For 29 years since then yields generally have declined.
Of the high inflation of the 1970s, Sylla said: “Bond investors demanded higher nominal yields — double-digit nominal yields in 1981 and 1982, because inflation itself reached double-digit levels in 1979-1981. The investor needed a high nominal yield to get a tiny real return. Then the [Paul] Volcker Fed broke the back of the inflation and yields in general tumbled.”
