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Initially revealed on February 8, 2023
Market overview
Municipal bonds posted their second-best begin to the 12 months in over 30 years, trailing solely the bounceback from the International Monetary Disaster in January 2009. Sturdy efficiency was pushed by improved supply-and-demand dynamics and rallying rates of interest, amid expectations that the Federal Reserve (Fed) will pause financial coverage tightening in early 2023. The S&P Municipal Bond Index returned 2.82% and significantly outperformed comparable Treasuries. Longer-duration (i.e., extra delicate to rate of interest adjustments) and decrease credit-quality bonds carried out greatest. The asset class has now garnered complete returns of seven.61% over the previous three months.
Issuance remained subdued at simply $23 billion, or 12% under the five-year common, and was outpaced by reinvestment revenue from maturities, calls, and coupons by over $5 billion. On the identical time, tax loss-driven outflows ended on the flip of the 12 months, and the asset class amassed $3.9 billion in web inflows in January. Regardless of wealthy valuations, enticing greenback costs and favorable taxable-equivalent yields stored retail traders engaged. Because of this, promoting exercise fell 36% month-over-month to only over $1 billion per day on common.
Given the outsized complete returns harvested in January, we’ve got shifted to a barely extra defensive posture and need to monetize beneficial properties as seasonal tendencies flip much less favorable in February. Whereas we anticipate that supply-and-demand technicals will stay supportive, we anticipate heightened volatility all through early 2023 in each rates of interest and efficiency because the Fed tries to engineer a comfortable touchdown.
Technique insights
We choose a barely quick length stance and are decreasing portfolio durations. We keep an up-in-quality bias general, however we’re including to our excessive yield allocation to make the most of the favorable risk-reward profile provided by low cost bonds. We like areas uncovered to vitality and commodities, native governments benefiting from altering demographics, and important service suppliers.
Obese
- Important-service income bonds.
- Choose highest high quality state and native issuers with broadest tax assist.
- Flagship universities and diversified well being programs.
- Choose issuers within the excessive yield house.
Underweight
- Speculative tasks with weak sponsorship, unproven expertise, or unsound feasibility research.
- Senior dwelling and long-term care amenities in saturated markets.
Credit score headlines Moody’s reported that delinquencies within the fourth quarter of 2022 rose within the non-rated section of the municipal market, reversing the downward development skilled earlier within the 12 months. In contrast to the rated universe of municipal bonds which can be primarily backed by defensive tax revenues and consumer charges for important companies, credit score threat is way increased for non-rated issuers which can be topic to aggressive stress and are susceptible to adjustments in financial circumstances. The spike in delinquencies is no surprise, with a lot of the issues concentrated in senior dwelling amenities and small healthcare suppliers coping with labor prices, in addition to stand-alone tasks that skilled value overruns and building delays. Trying previous the headlines, defaults in municipals stay uncommon with solely 0.1% of all issuers defaulting in 2022. With the likelihood of a U.S. recession rising, credit score deterioration throughout the municipal market will increase the potential for downgrades. Nevertheless, default threat will stay concentrated in a restricted section of the excessive yield market.
A spike in municipal credit score spreads needs to be seen as a possibility, and sustaining a diversified portfolio with strict issuer limits stays the optimum technique when investing in excessive yield municipals.
Municipal and Treasury yield actions
Municipal efficiency
