What Is the Muni-Treasury Ratio or M/T Ratio?
How to Calculate the Muni-Treasury Ratio
The muni-Treasury ratio, or M/T ratio, compares the current rates of municipal bonds with the current rates of U.S. Treasury bonds. It's a helpful tool for deciding which is a more attractive investment at the moment.
One way to assess the value of municipal bonds is to compare their yields to those of U.S. Treasuries. Be wary, though; this comparison is only a rough guide, not one that will provide hard-and-fast rules or indicate a definite move toward or away from one or the other.
What Is the Muni-Treasury Ratio or M/T Ratio?
The muni-Treasury ratio is a formula used to compare the rates of municipal bonds with U.S. Treasuries to help an investor decide which one represents a better investment. It uses indices from the Thomson-Reuters Municipal Market Data to evaluate ad compare the bonds' performance.
How Do You Calculate the Muni-Treasury Ratio?
The math behind the ratio is straightforward. You simply need to divide the yield on AAA-rated municipal bonds (munis) by yield on a U.S. Treasury of similar maturity.
In the formula, 'X' represents the maturity years for the particular bonds you are comparing. You would always compare 10-year munis to 10-year Treasuries, and so on. So, for example, if the yield on 10-year AAA munis is 1.5% and the yield on the 10-year Treasury is 2.0%, the ratio is 0.75. The higher the muni-Treasury ratio, the more attractive munis are relative to Treasuries. Throughout history, the ratio has averaged about 0.8.
Yields on municipal bonds are typically lower than those of Treasuries because the interest in munis is tax-exempt, whereas the interest on Treasuries is taxable. Therefore, investors generally require higher yields to invest in Treasuries.
How the Muni-Treasury Ratio Works
A number of factors impact what the muni-Treasury ratio is at any given time. The first factor is the base level, which is the average of the tax rates for municipal investors.
Assume the muni-Treasury ratio is 0.75. At that level, an investor in the 25% bracket receives the same after-tax yield on municipals and Treasuries. Also, assume that munis yield 3% and Treasuries yield 4%. The Treasuries investor receives an after-tax yield of 3% (4% x 0.75), so the yield on the two bonds is equal.
Over time, the two markets should reach an equilibrium based on the average tax rate of the investor base as people make buy-and-sell decisions based on their after-tax yields.
Unfortunately, it isn’t always that clean in real life. Other factors that go into determining the actual ratio include:
- Liquidity: The fact that munis are less liquid (i.e., less easily traded) than Treasuries affects pricing.
- Supply and demand: The two markets have distinct supply-and-demand dynamics. In past years, for instance, municipal bonds were supported by the combination of higher-than-normal demand and below-normal new supply, which helped boost their prices relative to Treasuries.
- Investors: The investor base in the two markets is also quite different. The Treasury market tends to have a higher representation of short-term traders, whereas the muni market is dominated by longer-term investors. As a result, municipal bonds often move more slowly than Treasuries, which in turn affects the ratio.
- Tax rates: The muni-Treasury ratio also reacts to expectations for future tax rates—not necessarily what the rates are at that moment.
Generally speaking, an M/T ratio above 0.8 is a signal that municipal bonds are a good buy.
The M/T Ratio Today
In the years following the 2007–2008 financial crisis, the muni-Treasury ratio ran well above the historical average. The primary reason for this is the aggressive policies of the U.S. Federal Reserve (the Fed) designed to fuel economic recovery, which included ultra-low interest rates and quantitative easing.
Since the coronavirus pandemic began, the ratio has fluctuated significantly but has still trended in favor of municipal bonds. The yield on munis is trending high in order to attract investors who are wary of the potential for municipal default in light of the economic crisis facing many cities. You can follow rates for municipal bonds and Treasuries daily to determine an up-to-date ratio.
In April 2020, Barrons reported that many economists were warning about the coming possibility of default on municipal bonds, so investors eager to take advantage of strong yields should be wary.
The Bottom Line
The muni-Treasury ratio is one tool investors can use to assess the value of municipal bonds. However, so many factors affect the ratio that it should always be considered in conjunction with the broader investment picture. Further, it’s important to keep in mind that municipals can still produce a negative return when the ratio is high.
This is because a downturn in Treasury prices is likely to be accompanied by a similar downturn in municipals (keep in mind, bond prices and yields move in opposite directions). A good rule of thumb is that it's better to choose your investments based on your own goals and objectives, rather than basing decisions on market conditions.
- The muni-Treasury ratio compares the yields on municipal bonds and U.S. Treasuries.
- An M/T ratio above 0.8 can indicate that municipal bonds are a better investment, but this is not always the case.
- Investors looking at bonds should always check the M/T ratio but be careful to weigh it with other factors and their own investment goals.