Municipal bonds are yielding more than they have in years. They’re a safe haven where defaults remain rare. And the bonds pay interest that’s tax-free.

But everyday American investors aren’t interested.

That’s because they’re snapping up cash-like products at a record pace with money-market funds and high-yield savings accounts offering yields above 5% and 4%. With the best-rated AAA municipal bonds only yielding between 3% to 4%, depending on the maturity, money has been flowing out of the muni sector.

“It’s certainly all about the 5%,” said Peter Crane, president of Crane Data, which tracks money-market funds. “That big round number is just a dinner bell to hungry investors.”

Persuading investors to get out of cash has been one of the key focuses of municipal-bond investment professionals this year. The lack of interest from mom-and-pop buyers has been a challenge to boosting performance in the $4 trillion municipal-bond market, where investment-grade debt has returned a measly 1%, according to Bloomberg indexes.

The Federal Reserve’s hawkish pause has added to the woes facing the sector, sending yields soaring on Thursday.

The central bank action has pushed up some yields on money-market funds to nearly 5.5% as of Sept. 20, according to data compiled by Crane. Those yields have lured in investors, pushing the assets of such funds to a record $5.64 trillion last week, data from the Investment Company Institute show.

While money-market funds have had a banner year, it’s been a disappointing one for municipal-bond mutual funds — the core buyers of state and local debt. So far in 2023, they’ve seen redemptions of about $6.2 billion, adding to last year’s record outflows of roughly $152 billion, according to LSEG Lipper data through the week that ended on Sept. 13.

“The enthusiasm for muni bonds has really slowed because you can get better, shinier rates with other things,” said Melissa Cox, a Dallas-based financial planner at Fetterman Investments. “We’re looking at more cash alternatives and things that are offering better yields without the risk at the moment,” she said.

While asset management companies highlight muni bonds’ tax-exempt interest payments — which means that the yields are typically lower than taxable alternatives — the bonds have failed to draw investors. Seeing their tax bills on the cash-like instruments they’ve been purchasing instead might convince investors to prioritize tax-free muni bonds, according to Crane.

But Wednesday’s FOMC meeting — when the Fed held rates steady but suggested another raise was still on the table for this year — likely means investors will still cling to their cash-like investments.

They are in danger of getting “caught in the cash trap” as they try to avoid taking on interest-rate risk, according to Paul Malloy, head of municipals at the Vanguard Group Inc. Investors in cash-like products are gambling with missing out on a bond market rally once the economy slows and the Fed eventually cuts interest rates.

“Cash rates will go down – you’ll be left to reinvest that money at lower overall rates,” he said. “You leave yourself with a lot of reinvestment risk.”

This article was provided by Bloomberg News.