During the month of July, muni bonds posted a third consecutive month of positive performance, with the S&P Municipal Bond Index rising +0.26%. A favorable technical backdrop drove this gain even as rates moved modestly higher as a result of strong economic growth, easing trade war fears, and more globally aligned central bank policy. (Bond prices typically move inversely with interest rates.)
Muni issuance maintained its recent trend over the month and largely underwhelmed versus historical averages at just $26.1 billion, the lowest issuance seen for the month of July since 2011. This brought the year-to-date total issuance to $178.0 billion, down -18% year-over-year. Reinvestment capital readily outstripped gross issuance, resulting in net negative supply of -$22.0 billion, the highest level since June 2012, exacerbating the seasonally driven technical tailwind.
Demand for the asset class remained relatively firm, displaying a bit more week-to-week volatility than in months prior. The stronger-performing areas included the intermediate part of the yield curve (5-10 years), the high yield sector led by Puerto Rico and tobacco, and lower-rated investment grade debt issued by New Jersey, Illinois, and Connecticut.
Looking to the fall months ahead, we maintain a cautious outlook on the asset class as strong performance has richened relative value measures. Also, technicals are poised to turn less favorable as the market typically transitions back to net positive supply in the fall. Risks may become heightened around upcoming events including global central bank meetings, midterm elections, and the curtailment of the tax benefit for pension buyers.
Strategy and positioning
As a result of the current environment, our strategy has been focused on reducing duration using a 0-2 year and 20+ year barbell curve strategy while actively hedging against rising interest rates. We continue to prefer lower-rated investment grade bonds given what we deem to be a limited opportunity set in high yield. We prefer revenue bonds over general obligations, particularly in the transportation, healthcare and housing sectors.
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This post originally appeared on the BlackRock Blog
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Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments.
There may be less information on the financial condition of municipal issuers than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. Some investors may be subject to federal or state income taxes or the Alternative Minimum Tax (AMT). Capital gains distributions, if any, are taxable.
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Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.
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