When Interest Rates Rise, Municipal Bonds May Help Stabilize Your Portfolio

When Interest Rates Rise, Municipal Bonds May Help Stabilize Your Portfolio

After years of zero-bound rate policy, possible interest-rate hikes are in the forecast this year. Because the current rate-hike cycle is the first in nearly a decade, it’s understandable that many investors feel like they’re entering uncharted territory.

It’s anticipated that the tightening cycle will be gradual and modest until a 3% rate is reached. Since the market has been aware of the rate hikes for some time, they should not cause alarm. As expected, rising interest rates are generating greater interest in—and greater need for—tax-efficient investment options among investors.

This is where U.S. municipal (muni) bond mutual funds can play a vital role in potentially minimizing volatility within investors’ portfolios. Munis may help defend a portfolio against Fededral Reserve rate hikes, preserve investment income seek to dampen the negative price impact of higher interest rates. Now may be the time to learn more about the multiple characteristics of munis.

How Trump’s Tax Proposals Could Affect the Municipal-Bond Market


The Trump administration’s tax proposal, which calls for lowering the corporate tax rate to 15% from 35%, as well as dropping the top marginal federal rate to 35% from 39.6%, has been greeted with indifference by the municipal-bond market thus far. Both the municipal- and Treasury-bond markets have taken the announcement in stride with rates and ratios changing only slightly.

We assign a low probability to the passing of a corporate tax-rate reduction to 15% and markets seem to agree. The administration’s proposed tax-reform package and market impact bears watching closely, however, as it winds its way through the legislative process.

Perhaps the most impactful part of the plan calls for lowering the corporate tax rate to 15%. This proposed cut in the corporate rate is significant as the lower tax rate would reduce the appeal of tax-exempt bonds for the insurance companies and banks that hold 14% and 15% of outstanding municipal debt, respectively.

Standish believes that while demand from these institutions could decrease gradually as a result of this lower tax rate, widespread selling is unlikely. Accounting conventions should keep insurance companies from rapidly selling off municipal bonds and the favorable risk/reward and liquidity characteristics of these bonds continue to make them attractive investment propositions.

Other provisions of the Trump tax proposal offer even less chance of disrupting the municipal-bond market. A proposed cut in the top individual income-tax rate from 39.6% to 35% would likely have a negligible impact. Previous cuts to top marginal rates, such as those enacted during the Ronald Reagan and George W. Bush administrations, had no discernible impact on municipal-bond pricing; also, historically, municipal-bond yields have consistently been higher than the prevailing implied tax rate relative to Treasuries.

As Interest Rates Increase, the Appeal of Munis Can also Rise


The key reason is the tax-exempt income that munis offer may become more attractive to investors as rates increase. A brief overview of munis may be helpful:

  • They offer a potential source of income that’s free from national, and sometimes state and local, income taxes.
  • This enables investors to pursue potentially higher current income on an after-tax basis without being exposed to risks that may accompany higher-yielding, non-investment-grade options.
  • When interest rates rise, investors may tend to step up their purchasing of munis to lock in higher yields, which can increase their appeal.

Because investors have historically tended to hold muni bonds to maturity, there may be fewer munis available precisely when more investors are finding them attractive. This is where muni funds can become a compelling option for investors seeking the benefits of munis without purchasing individual muni securities.

The Relative Steadiness of Munis Is Unique



Collectively, individuals and households own over two-thirds of all muni bonds directly or through funds.

This means muni bonds’ valuations have typically responded to demand among these groups. Because both individuals and households have tended to stick with muni investments, rising interest rates may pose less of a threat for those who hold muni bonds to maturity. As a result:

  • Changing rates and yields may not affect an investor’s total return.
  • Investors receive regular interest income as well as the value of the bond at maturity.

This illuminates an important perspective for investors to consider:

  • Rising rates may offer investors the opportunity to reinvest the income their bonds yield into newly issued, higher-yielding bonds.

Fixed Income Expertise When It’s Needed Most


Dreyfus offers an extensive selection of municipal bond funds, managed by an affiliated subadviser, Standish Mellon Asset Management Company LLC (Standish), an established firm dedicated to serving sophisticated fixed income investors. Significantly, the investment strategies Standish offers span both taxable and muni fixed income disciplines. Standish stands out due to its:

  • History that dates back to 1933.
  • Experience in managing municipal bond portfolios through many interest-rate cycles.

Active management gives the Standish portfolio managers the ability to address rising interest rates as they unfold — and this can help minimize volatility in an investor’s overall portfolio.


For example, Standish research shows that over 3-year rolling periods, yields on 10-year municipal bonds have historically exhibited only 60% as much volatility as 10-year Treasuries. Standish expects muni bonds with longer maturities, particularly those greater than 10 years, to show significantly less volatility than 10-year Treasuries. We believe this represents a timely opportunity and could enhance investors’ confidence in a rising interest-rate environment, particularly those who feel they are entering an unfamiliar reality of higher rates.

An Array of Options to Meet Investors' Needs


Based on your goals and risk tolerance, among other factors, Dreyfus may have a solution to meet your unique needs and objectives.

In addition to mutual funds, Dreyfus offers separately managed accounts in a range of asset classes and investment styles, all managed by professional asset managers. Learn about the Dreyfus Managed Asset ProgramSM  (DMAP), and Standish, the portfolio manager for the DMAP Municipal Bond series separately managed accounts. With a DMAP Municipal Bond Series separate account, an investment option under the Dreyfus Managed Asset Program, a wrap-fee, investment advisory program, you own the individual bonds in your portfolio. Standish’s tax-sensitive team uses its expertise to construct laddered portfolios across a 10-year range that seek to help you manage interest-rate risk. These ladders represent a conservative approach, with all bonds rated AA- or better. If Standish determines that, because of credit deterioration, a bond in the portfolio may see its rating fall below AA-, a sale of the bond will be recommended. Wherever possible, in these situations Standish seeks to sell prior to the rating agency downgrade.


1Investors should consider the investment objectives, risks, charges and expenses of a mutual fund carefully before investing. To obtain a prospectus, or a summary prospectus if available, that contains this and other information about a Dreyfus fund, contact your financial advisor or visit Dreyfus.com. Read the prospectus carefully before investing.

Asset allocation and diversification cannot assure a profit or protect against loss. 

Bonds are subject to interest-rate, credit, liquidity, call and market risks, to varying degrees. Generally, all other factors being equal, bond prices are inversely related to interest-rate changes and rate increases can cause price declines. The amount of public information available about municipal securities is generally less than that for corporate equities or bonds. Legislative changes, state and local economic and business developments, may adversely affect the yield and/or value of municipal securities. Other factors include the general conditions of the municipal securities market, the size of the particular offering, maturity of the obligation, and the rating of the issue. Income for national municipal funds may be subject to state and local taxes. Income may be subject to state and local taxes for out-of-state residents. Some income may be subject to the federal alternative minimum tax for certain investors. Capital gains, if any, are taxable.

The Bloomberg Barclays 10-Year U.S. Treasury Bellwethers Index is a universe of Treasury bonds, and used as a benchmark against the market for long-term maturity fixed-income securities. The index assumes reinvestment of all distributions and interest payments. An investor cannot invest directly in any index.

The Dreyfus Managed Asset ProgramSM (DMAP), a wrap-fee, investment advisory program, provides a comprehensive disciplined strategy for helping you achieve your long-term investment goals. The program provides a sophisticated, quantitative process for analyzing your investment objectives and helping to optimize your asset mix on an ongoing basis. You will receive professional guidance from a Dreyfus Advisor to help you develop a personalized investment plan and select from a carefully screened selection of mutual funds to implement your investment plan. Investors should speak with their advisor, who can provide more information about the program including the fee schedule and services provided under DMAP, and its appropriateness for your investment portfolio.

The minimum account balance for Dreyfus Managed Asset Program Mutual Fund Series is $25,000. Equity separate account portfolios within the Customized Investment Series require a $100,000 minimum. Dreyfus Municipal Bond Separate Account Series national portfolios require a $300,000 minimum and state-specific portfolios require a $500,000 minimum. 

Dreyfus Advisor Services is a division of MBSC Securities Corporation (MBSC), an indirect wholly owned subsidiary of The Bank of New York Mellon Corporation. MBSC is a dually registered investment adviser and broker-dealer and a member of FINRA. Dreyfus Advisor Services participates in wrap-fee programs, including the Dreyfus Managed Asset ProgramSM. MBSC Securities Corporation and Standish Mellon Asset Management provide investment management services under these arrangements. Standish Mellon Asset Management Company, LLC and The Dreyfus Corporation are affiliated BNY Mellon investment management subsidiaries. BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation.

This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular investment, strategy, investment manager or account arrangement. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Please consult a legal, tax or investment advisor in order to determine whether an investment product or service is appropriate for a particular situation. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.  The Dreyfus Corporation, Standish and MBSC Securities Corporation are companies of BNY Mellon. ©2017 MBSC Securities Corporation, Distributor, 225 Liberty Street, 19th Floor, New York, NY 10281.