Fund Flows Weigh on Muni Market

While there has not been outright panic or a material sell-off caused by the bankruptcy filing of the city of Detroit, the event is still putting downward pressure on the market as a whole through tax-free bond mutual fund outflows.  Municipal bond funds have experienced outflows for the last several months, and while they started with seasonal liquidations for tax payments and continued with rising rates in May and June, concerns related to Detroit have kept the pace up despite rate stabilization in the Treasury market.  Outflows decelerated last week to just under $1 billion but that is still a large number in relative terms.  The ongoing outflows have caused municipal bonds to under-perform Treasuries especially those with longer maturities as Intermediate funds have been hit the hardest.  20 year Municipal/Treasury ratios have expanded to 116%, while 5 year ratios are stable around 96%.  Bond maturity cash flows to re-invest are generally the highest during July and August for the municipal market and this likely helped support the market from further deterioration relative to Treasuries.  In addition to keeping the pressure on fund outflows, the Detroit filing has also put pressure on lower rated issuers with BBB rated issues under-performing top rated debt by about 100 basis points since the filing occurred on July 18th.  We are taking advantage of this sell off for our clients by using our ongoing credit analysis and trading skills to purchase higher yielding quality credits with incrementally lower ratings while avoiding the truly troubled entities.