When evaluating the municipal market, a consistent topic of conversation for us is the technical environment, which is basically a measure of supply and demand.
Municipal bond funds and ETFs have exhibited a fairly consistent pattern over the last 10 years whereby redemptions occur during periods of rising Treasury rates. The last few weeks have been no exception. Since late August, the 10-year U.S. Treasury yield has risen from around 2.8% to 3.2%. The two main data providers on fund flows, Lipper and ICI, have reported that muni funds and ETFs have faced outflows for seven straight weeks through 11/7, the first sustained period of outflows since immediately following the 2016 presidential election.
On the supply side, in October the market absorbed two of the heaviest weeks of supply this year, as several large new issues came to market.
Despite these headwinds, the municipal market generally remained on stable footing. As shown in the chart below, the ratio of municipal bond yields versus Treasury bond yields (a proxy for municipal richness/cheapness) remained fairly close to August levels, before any outflows had occurred. Credit spreads, or the additional yield demanded by investors to take municipal credit risk, have also remained relatively stable and currently sit at the YTD average. Looking at total return performance of the market broadly, the ICE/BAML municipal master index has performed in line with the ICE/BAML Treasury index in recent weeks.
It is expected that technical factors will become more supportive through January, as supply is expected to slow. With Treasury yields having stabilized and the midterm election cycle behind us, we would expect the pace of outflows to slow or reverse as well.
Both the market’s ability to absorb outflows and an uptick in primary supply without a major hiccup should be viewed as positive. Coupled with the improving technical environment, performance relative to Treasuries is likely to be supported through the end of the year.
Sources: Barclays, ICI, Lipper