Muni Bonds – No Longer Being Gobbled Up

Muni yields have risen for 11 straight days, the longest losing streak since 2013, and have now reached 16-month highs. In stark contrast to earlier this year, when municipal bond mutual funds had a record streak of inflows and demand could not be satiated, investors have lost their appetite. Municipal bonds have experienced relative underperformance during the second half of the year as a confluence of factors has pressured the market. As we moved through the end of the 3rd quarter a major surge in supply overwhelmed demand, especially as fund inflows began to dwindle. Concurrently, Treasury rates began to drift upward, which, all else being equal, usually results in municipal outperformance.

However, due to the surging supply, muni bonds struggled. Following the election, Treasury rates spiked over a short period of time and fund outflows accelerated, with over $4 billion exiting in just the first week, according to ICI data. Rising rates have traditionally triggered redemptions in municipal mutual funds, and that, combined with fears of tax reforms, have forced sales, thereby causing muni bond yields to climb more than Treasuries during the recent sell off. Ten-year AAA municipal yields have now moved above 101% of Treasuries for the first time since early in the year. Bonds offered for sale hit a 5-year high recently, according to Bloomberg data, highlighting the pressure on the market and foretelling more outflows from the fund space.

Taking a step back, however, we see stabilizing Treasury rates and expectations for shrinking supply through the rest of the year, as the Bond Buyer’s 30-day visible supply came in more than 30% below the YTD average. Further out we see potentially lower supply for the upcoming year. Refunding issues has accounted for about 60% of total supply in the last couple of years, and as rates move up those issues will make less economic sense for issuers, likely causing supply to fall despite various bond authorizations in the November election season. 

hile redemptions may continue in the near term, the recent bout of volatility has created more attractive pricing and will create opportunities for investors, which we look forward to. It is also important to remember that our client portfolios contain individual bonds that have the powerful property of a maturity date. So while the paper value may fluctuate when the market environment changes, we have the ability to let our bonds mature and use those proceeds to take advantage of the now more attractive yield environment.