It All Comes Down to Confidence!

For now, we would suggest the U.S. Treasury market is grappling with chronic fatigue coming from a combination of inflationary, growth, and stimulus emotional headwinds. In a perfect setting, these would all be positive conditions, yet market volatility and anxiety prevail. Admittedly, the forces now driving bond yields higher are largely engineered as opposed to more organic conditions. The soon-to-be enacted fiscal relief package, which comes in just shy of the $2 trillion Cares Act passed one year ago, and exceeds last December’s $900 billion fiscal plan, extends the engineering process even further with recovery-centric spending, expanded unemployment insurance benefits, additional direct payments to households, funding for state and local governments and earmarked allocations for vaccination distribution as well as for virus testing programs.

Perhaps now that new relief is here, the bond markets may be able to breathe a sigh of relief given that the “stimulus” narrative may take a much-needed break. But let’s not forget that Congress expects to soon craft a longer-term economic recovery plan that targets job formation, infrastructure investment and climate change needs. We believe that the time has come to carefully gauge the need for more fiscal relief, particularly as previously approved funding has yet to be distributed. We are not suggesting that a bold infrastructure initiative is not needed, in fact we would view such as being accretive to the overall growth trajectory as well as contributory to our nation’s competitive standing and national security interests. While we appreciate any and all financial consideration for our pandemic-afflicted credit cohorts, we take the position that a more surgical approach is the best course to follow going forward. For some time now, we have been supportive of the efforts to preserve municipal credit standing with specific funding made available to those sectors of the asset class that have experienced the heaviest financial and operational dislocation. We especially applaud the relief made available to state and local governments, mass transit, higher education, public schools, health care providers, and to our domestic airports.

Again, we are mindful of the uneven pandemic impact upon state and local finances, but the funding will enable many municipal governments to not only avoid some rather deep spending cuts, but to also preserve delivery of essential services in the areas of healthcare, public safety and educational programs. All in all, funding allocations are expected to be accretive to municipal credit quality which should help to return various sectors to a stable outlook. Throughout the pandemic, munis have been buoyed by very compelling market technicals which have produced top-range returns for 2020, although under-performing UST last year, and out-performance for 2021 YTD. Bond market behavior over the near-term is likely to be guided by inflationary expectations. It is only logical to expect upward price pressure given consumer engagement and overall demand prospects rooted in the nationwide vaccination process, direct stimulus awards, and more people returning to the workforce. We continue to believe that elevated fears of inflation have been overdone and that pressure is more likely to be transitory. If the bond market can find more comfort with the inflationary path, then we think that prices could settle into a less volatile trading range. Should this scenario play out, we could see perhaps a sustained rally in the Treasury market. For those naysayers, we do not expect the new stimulus alone to produce out-sized inflation.

We do think that muni technicals will remain a key component of the performance narrative. Nevertheless, our initial expectations for 2021 fund flows seem to be ringing true given a slowing in the pace of inflows and even the first outflows in about four months. We think that retail investors are trying to reconcile the higher range of tax-exempt yield levels post-selloff with presently rich valuations. Perhaps price discovery with more pronounced secondary bid-wanted activity is playing a role in this environment as comfort levels are being sought, yet we do believe that the technical foundation has the ability to return fund flows to a more sustained positive trajectory and yes this would rely, in part, on a more stabilized Treasury Market. At the risk of sounding like a broken record, investors are advised to seek opportunities when and where volatility presents itself.

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