Muni Bonds Buck The Trend

by: BlackRock

Munis posted positive results in June, typically the market’s third-worst month.

Issuance remains muted post tax reform while demand remains remarkably firm.

Valuations have slightly improved and typical summer strength may provide a boost.

Market overview

Muni bonds rewarded investors with an unexpected positive return in June (+0.13%), against the odds that a stark pickup in supply would saturate the market as history suggests for this time of year. The market’s persistently strong technical environment provided solid footing for muni bonds to benefit from interest rates remaining range-bound amid geopolitical uncertainty and mounting fears around the impact of international trade wars. (Bond prices typically move inversely with interest rates.)

Issuance continues to be depressed in 2018 as a result of tax reform (which eliminated the exemption for advanced refunding bonds), down 19% year-to-date versus the same period last year and remaining below the 5-year average. The reinvestment of payouts from calls, coupons and matured bonds outweighed gross supply in June, driving prices higher. The benefits of this net negative supply environment were slightly mitigated by activity in the secondary market, where dealer inventories remain bloated.

Demand has remained firm, with eight consecutive weeks of mutual fund inflows since the tax-time surge in short-term fund selling. Short and intermediate term issues outperformed longer term bonds in June. High yield muni bonds were among the stronger performers of the month, led by Puerto Rico and tobacco bonds. Prerefunded bonds and New Jersey issues also provided generous returns for the month.


Heading into the late summer months, historically a period of net negative supply following the spring supply push, we hold a positive view on the muni market, particularly as relative valuations have reset to slightly more attractive levels. Looking further ahead into the fall, we anticipate taking a bit more caution as we watch for event risks relating to a potential third Fed rate hike, midterm elections, and the curtailment of the tax benefit for pension buyers.

Strategy and positioning

As valuations have become slightly more attractive and historical seasonal trends suggest favorable conditions are around the corner, we’ve shifted to a slightly longer-than-neutral stance on duration (interest rate risk) while maintaining a barbell yield curve strategy. We prefer lower-rated investment grade credits and revenue bonds for their ability to provide income, and we remain neutral on high yield.

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