Munis Took Performance Back in July
- August 7, 2019
We still believe that continued retail interest will drive performance through Q3 and into the fourth quarter of 2019.
Tax-exempt bond prices moved to higher ground throughout July, with the back end of the month seeing trading done in a much tighter range ahead of the Federal Open Market Committee (FOMC) meeting. Once the announcement of a 25 basis point rate cut was released, muni yields followed United States Treasury (UST) lower, but the fixed income rally was extended as President Trump escalated the trade tensions with threats of imposing additional tariffs on Chinese imports, thus raising the bets for further policy easing to temper a slowing global economy. As we try to gauge the impact of new tariffs upon Chinese imports, we would expect the haven bias to dominate the investment narrative over the near-term as the trade story encourages the market doves seeking enduring momentum towards lower rates in response to rising global uncertainty. This dynamic should bolster muni performance even with easing technicals.
We would ascribe the muni out-performance relative to UST to a very constructive technical backdrop highlighted by fairly light issuance patterns and strong seasonal reinvestment demand. Beyond August, reinvestment needs are expected to taper, giving rise to a weaker supply/demand dynamic, yet we still believe that continued retail interest will drive performance through Q3 and into the fourth quarter of 2019. Demand for munis continues to demonstrate unwavering support as the desire for tax-efficient investment has now led to 30 consecutive weeks of positive municipal bond mutual fund flows.
We believe that advancing volatility throughout the remainder of the year could make for more pronounced opportunities. If we do see expanding new-issue supply, we would expect this to come with better price discovery and improved liquidity conditions. For now, the relative tightness in quality spreads does not seem to provide fertile ground for extending risk. For the more conservative oriented investors, portfolio repositioning should reflect the potential impact of a shift in the economic cycle and so trading up in credit quality may be appropriate.
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