Much of the recent attention on financial markets has focused on the equity market volatility. Not to be outdone, the normally stable and lethargic municipal bond market experienced a historical spell of volatility over the last couple weeks as well.
Municipal bonds – the debt of state and local governments used to fund essential services or infrastructure projects – are a resilient asset class meant to provide safety and assurance to their investors. First and foremost, they provide a consistent stream of income through regular coupon payments and ultimately preservation of capital over the term of a bond. Of course, throughout the life of a bond the prices will change, and the fluctuation due to recent market forces deserves a closer examination.
Here are a few factors contributing to the recent moves in municipal bonds:
- Extreme selling pressure on mutual funds and ETFs, a trend that started in corporate and high yield bonds, finally infiltrated the municipal market. After 60 consecutive weeks of inflows to municipal bond funds, where average inflows totaled $1.5 billion, this trend reversed for the week ended March 13. A $12 billion outflow, 10 times the weekly average put pressure on fund managers to disrupt the regular management of their portfolios to meet redemption. This means selling bonds at any cost, regardless of credit. Simply put, there were way too many sellers in the market.
- As a result, municipal bond prices declined sharply, in some cases as much as 10-15% even on AAA credits. Conversely, yields on municipal bonds spiked. For example, last week we purchased a Berkeley CA School District 4% Bond with a AA+ rating, July 2028 call and a July 2038 final maturity. We purchased this bond at a 3.5% tax-free yield to that 8-year call. Just two weeks ago, this same bond was yielding 1.2% to that call date.
- Municipal/Treasury ratios reached historic levels. The 10-year muni/TSY ratio reached 350% last week, the highest of all-time. For context, the long-term historical average for this ratio is about 80-85%. The Berkeley CA bond referenced above was purchased right around that 350% of TSY level. We haven’t seen bonds even close to this level since 2016, when the presidential election caused a surge in municipal bond yields. When these ratios and levels get out of balance, active managers like us will put cash to work and comparative forward returns on these trades tend to be well above average because of the tactical entry point.
- The Berkeley bond is one of several bonds we purchased over the last couple weeks to take advantage of the extreme dislocations in municipal market pricing. We believe strongly in the long-term viability of high-grade municipal bonds and we are happy to grab these generational discounts.
- After this abundance of purchases last week, the municipal market has since tightened. Municipals bonds staged their largest rally in over 30 years on Wednesday following supportive measures from the Federal Reserve and Congress. However, the window of opportunity is not completely closed. 10-year AAA municipal bonds still yield close to 180% of an equivalent US Treasury, so relative value can still be found for investors willing to spend time to find it.
At MacroView, we are municipal fixed income specialists. We understand the value of active management in this $3.8 trillion market. We further appreciate the effort and attention to detail required to effectively manage municipal portfolios for individual clients and other advisors. Please reach out if you need a strategic partner who understands the best ways to navigate and capitalize on the inefficiencies of this important asset class.
The MacroView Bond Group