The Upside of Munis’ Down Market
Bond supply is plummeting, but so is demand. And rates are rising. Where are the silver linings?
After its worst first-quarter in 22 years, the municipal bond market extended its losses in April, with yields continuing to climb. Market yields rose five to 20 basis points across the curve last month, pushing all sectors of the market, excluding ultra-short strategies, deeper into negative territory.
Over the first four months of 2018, supply shrank 20% year-over-year. That should have been a boon for bond prices, but the reduction in supply has been offset by significant retrenchment in demand from banks and insurance companies following last December’s tax reform.
What now remains to be seen is how retail investors react to any further negative performance. Household sector assets now account for $1.6 trillion in municipal holdings – roughly 40% of the market – and a rush to the exits could lead to further downward pressure on prices. While painful, that could create attractive entry points for longer-term muni investors following recent years of higher-risk and lower-reward propositions in the space.
Will rising benchmark interest rates spark a muni bond fire? The U.S. Federal Reserve stayed its hand at its May 2 monetary policy meeting, and indicated it’s committed to a gradual path of policy normalization through a combination of increasing the Federal funds rate and shrinking its “quantitative easing”-inflated balance sheet by allowing maturing bonds to roll off it. This could lead to more problems for fixed income, but there are a couple silver linings for municipal bond investors.
Munis have performed well so far in 2018 relative to other fixed income asset classes, including Treasuries and corporate bonds.