Munis Still Disengaged From Treasuries, But Is The Tide Shifting?

Issuers and buyers are finding comfort with stabilizing yield levels that are, for the most part, trying to find a more appropriate range. While more discovery is likely to take place in May, we believe that new-issue product can continue to be placed with those larger, more well-known names having solid credit fundamentals being greeted with favorable yield treatment. We can expect to see more deals coming oversubscribed and upsized provided that technicals stay the course. Issuers large and small that possess weaker credit profiles can be expected to encounter greater yield penalty. Throughout the remainder of the year, we can expect primary volume to lag traditional expectations, and again, this will be driven by public health policy status, the impact of Fed and congressional intervention, and the degree of credit erosion and uncertainty. If all touchpoints move in a positive direction, we can expect to see better supply in May and beyond and if demand rises to the occasion, we will allow ourselves to be cautiously optimistic.

The muni secondary market is still managing headwinds given remaining bid-wanted activity and a degree of portfolio re-balancing from our institutional buyers. Secondary price discovery, while much improved, is still challenged and rate volatility continues to emerge. Caution against an uncertain credit backdrop is evident and the tone may not shift until there is encouraging signs that the economy can wage a successful reopening. While Treasuries remain the haven investment of choice, the performance gap between the two asset classes has narrowed considerably month-over-month, reflective of the easing muni market conditions which include a functioning primary and a more efficient, albeit still discoverable, secondary. The world of public finance had certainly been upended in March, yet April saw the working components coming back together as both the Fed and Congress catalyzed renewed confidence. The measures undertaken by the Fed are indeed bold, but we do believe that further policy actions will likely be needed, and certainly we hope that this will include additional fiscal relief from Washington.

Credit certainly remains under pressure and we will continue to see adverse ratings actions even after the economy fully re-opens. We suspect that there will be more events of technical defaults than actual monetary defaults, and defaults overall will be limited. While chapter 9 filings may become elevated, we do not see outsized bankruptcy scenarios stemming from the COVID-19 crisis. For now, fund flows are demonstrating anticipated market anxiety given that consecutive weekly inflows are not sustainable with the ongoing levels of uncertainty. Flows turned negative for the last reported period and unless the muni market returns to March level disruption, we can expect the future pace of fund flows to reflect a more balanced sentiment. Again, we see the muni asset class as displaying a high level of resiliency against a broader investment portfolio during uncertain times.

The underperformance of Munis relative to UST can be expected to continue for a while as credit remains at the heart of the investment calculus. However, we do see the muni asset class becoming more reengaged with Treasuries as better functionality and confidence continues to underscore the public finance space. This observation should create value opportunities for both traditional and crossover muni buyers who may be inclined to provide a bid given still historically cheap relative value ratios and compelling absolute yields compared to other domestic and/or global offerings.

For a comprehensive portfolio evaluation of your municipal holdings, please contact your Oppenheimer Financial Advisor.