Those April Showers Brought May Muni Flowers
- June 4, 2020
While the shutdown has brought about damage of great significance, we do not view the damage as insurmountable
Through the collective efforts of creative policy intervention, rational determination, and realistic expectations, there is a positive outcome that extends to our economy in general and to the municipal bond market more specifically. The endurance of May’s muni rally caught many of us by surprise, but this goes to demonstrate the power of technical factors against a backdrop of comforting monetary and fiscal policy intervention at a time when it is needed most. Given all of the positive market attributes, such as strong reinvestment demand, lighter supply, positive fund flows, manageable dealer inventories, and substantial outperformance in May, one would not know that muni credit is under considerable pressure with much of the state and local economies shuttered for several months.
While not all municipal credits are created equal, the vast majority of issuers understand that they are in the business of providing certain inalienable essential services such as public education, police and fire safety, healthcare, and highway construction and maintenance. These services do not disappear no matter what the financial or operational challenges look like and generally, local governments do not simply go out of business. This basic tenet has served the asset class well and has historically complemented the tax efficient nature of municipal bonds. Having said this, we continue to posit that current yield levels are not adjusting for potential credit challenges, but are rather being guided by market technicals and a mesmerizing dose of confidence. Nevertheless, market participants will remain sensitive to any surge in credit concerns with potential reaction to unforeseen headline items.
The endurance of May’s muni rally caught many of us by surprise, but this goes to demonstrate the power of technical factors against a backdrop of comforting monetary and fiscal policy intervention at a time when it is needed most.
We expect a continued monthly re-build of the new issue calendar and more normalized issuance patterns as long as confidence holds in and we avoid a March-like market dislocation. We expect the issuer mindset to reflect varying considerations as we move forward, and if the outlook holds in we can expect to see a further normalization in the types of issuers and structures coming to market, many of which have chosen to remain on the sidelines as they re-evaluate budgetary needs and flexibility as well as new-found deficits, along with their appetite for additional debt against a compromised credit backdrop.
One of our recurring themes, even before COVID-19, has been the outsized availability of cash ready for deployment, and the current trend of positive mutual fund flows strengthens this observation even though credit pressure remains front and center to the investment calculus. Strong investor demand comes at a good time as seasonal supply technicals take hold. The weaker short-end muni returns last month can be attributed to a pent-up demand for longer dated securities following a focus on short maturities in April due to all of the Fed’s newly crafted liquidity facilities and swelling credit concerns. A growing outlook for higher personal and corporate income tax rates contributes to a push further out on the curve.
For a comprehensive portfolio evaluation of your municipal holdings, please contact your Oppenheimer Financial Advisor.