Spring Is Here and Munis Are in Bloom

As we turn the page in our calendar to April, we do so with an optimistic outlook for the start of the second quarter, recognizing that we are in a very different place compared to one year ago. While there is undoubtedly advancing volatility across multiple asset classes, much of the associated uncertainty can be tied to positive developments surrounding our economic recovery and the associated outlook for growth and inflation. We view the recovery as being ahead of expectations and we have consistently aligned ourselves with the guidance set forth by Fed Chair Jerome Powell and other members of the FOMC, acknowledging that the timing of “liftoff” is not necessarily unanimous among policymakers. While the specifics of President Biden's infrastructure initiative generally come as no surprise, actually looking at the numbers can be quite sobering, and while there is bipartisan support for a national infrastructure plan, we suspect that the proposed hike in the corporate income tax rate from 21% to 28% - again no surprises here – as a funding vehicle will be the key point of contention between the Democrats and Republicans. To what extent the budget reconciliation process will be used remains unclear at this time, but if an insufficient number of Senate Republicans align with the Democratic majority, we suspect it may be put in play. We would also mention that it would take some time before the money begins to flow through the economy given the rather extensive procurement, environmental, general approval, design, permitting, and construction processes involved. Nevertheless, we suggest the potential for more activist participation from the Public Finance community and the Municipal Bond Market.

Over the past two months, municipal bond yield movement found it difficult to completely break free of the unrelenting sell-off taking place in the U.S. Treasury market, yet very supportive muni technicals actually held the asset class to a relatively tighter trading range in March. Demand has kept munis well-performing and on a different return trajectory than the one followed by UST. Our view continues to avoid a meaningful technical shift in the muni market and so a more aggressive and sustained back-up in yields does not appear likely. Prospects for higher taxes, both individual and corporate, are also likely to temper further yield advances. But again, we maintain that munis would find it difficult to function in isolation of the Treasury market’s concerns over inflation, thus somewhat limiting a more sustained downside momentum for relative value ratios.

If conditions persist, we do not see taxable transactions matching last year’s contribution to overall supply of 30%, and we think our beginning-of-the-year projections for taxable issuance coming in at closer to 20% seem more realistic given a higher rate environment and what may be a more desirable appetite for tax-exemption with prospects for higher corporate and individual tax rates. For now, we see continued out-performance by the muni asset class as long as technicals hold in, and we think they will. We note rather lofty amounts of sidelined cash still seeking investment guidance, and with the potential for higher, more attractive yields, there is ample room to put much of this money to work. Fund flows and ETF contributions have been quite active and we expect this trend to continue given a number of intersecting factors that have made munis the fixed income investment du jour!

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