Municipals Deliver Strength Ahead of Seasonal Shift

February update

  • Municipals posted positive performance and outperformed comparable Treasuries in February.
  • We expect supply-and-demand dynamics to turn less supportive in the coming months.
  • After patience to start the year, we would view any material backup as an opportunity to buy.

Market overview

Municipal bonds posted modestly positive performance in February as the macro-backdrop remained the focus. Interest rates rose considerably amid firm economic growth, a surprising uptick in inflation, and a message of continued patience from the Federal Reserve. Favorable supply-anddemand dynamics prompted strong municipal outperformance versus comparable Treasuries. The S&P Municipal Bond Index returned 0.08%, bringing the year-todate total return to -0.08%, with coupon return slightly outpacing negative price return. The 20-year part of the yield curve and lower-rated credits performed best.

Issuance was $31 billion in February, 2% above the five year average, bringing the year-to-date total to $62 billion. Supply was outpaced by reinvestment income from maturities, calls, and coupons by over $5 billion. As a result, deals were well absorbed, oversubscribed 5.3 times on average. At the same time, demand remained firm. Mutual fund flows waned slightly from the levels experienced in January but stayed consistently positive, led by the high yield sector.

Seasonals turn less supportive in the coming months as the market transitions to net positive supply in the spring. March has historically been one of the worst-performing months of the year, typically pressured by a month-overmonth swell in issuance. This year, supply could be further exacerbated if issuers are successful in their efforts to trigger the extraordinary redemption provision to refinance Build America Bonds in the tax-exempt market. However, given our patient approach earlier in the year, we would welcome a market correction and view any material backup as an opportunity to put cash to work at more attractive absolute and relative valuations.