The Muni Money Train Holding Tight On The Rails

by Jeffrey Lipton May 10, 2021

Muni spreads continue to grind tighter, thus making it challenging to locate value. We are presently observing a tale of two retail buyers, one that is searching for value and is tough to commit, and one that is consistently looking for tax-efficiency and high credit quality and is an easier sell. The new issue market continues to show strong and welcoming reception as supply remains manageable and reinvestment needs are about to intensify for a while. Going forward, tighter spreads and richer relative value ratios can come about, particularly as looming tax increases amplify the value of tax-exemption, although we have to question just how much lower ratios can go and how much tighter spreads can become. As a sign of muni market inspiration, one simply has to parse the April volume and performance data. According to Refinitiv, overall municipal issuance rose 6.2% in April year-over-year totaling $33.65 billion. With just one-third of the year behind us, the April advance places 2021 volume on track to surpass last year’s record issuance of just over $480 billion.

Much of the rise in volume last month can be ascribed to new-money transactions, which almost tripled April’s refunding issuance as the universe of refunding candidates thinned a bit given interest rate sensitivities and as issuers took advantage of a strengthening credit backdrop supported by multiple rounds of fiscal relief. We suspect that new-money issuance through the balance of the year will be guided by the state of muni credit and levels of capital needs just as refunding activity will likely remain influenced by interest rate shifts.

At the beginning of the year, we forecasted aggregate issuance between a range of $420 - $440 billion predicated upon a more conservative view of issuer willingness to take on new debt at a time of severe budgetary challenges and constraints. A stronger-than-anticipated recovery with a sooner-than-expected return to a stable outlook for various sectors would seem to loosen up this range and so we are compelled to revise our volume forecast higher to a new range between $450 - $470 billion. While events and circumstances may impact issuance trends, there are very real prospects for a record issuance year in 2021 as long as the stars line-up.

We note rather lofty amounts of sidelined cash still seeking investment guidance, and with the potential for higher, more attractive yields along with a generally favorable credit outlook, infrastructure buzz, and ESG investment needs, there is ample room to put much of this money to work.

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 (although likely to be tempered by prospects for higher individual and corporate taxes) along with a generally favorable credit outlook, infrastructure buzz, and ESG investment needs, there is ample room to put much of this money to work. Fund flows and ETF contributions have been quite active, although we note some recent slowing that should not signal a shift in trajectory, and we expect a trend of ample flows to continue given such intersecting factors that are making munis the desired fixed income investment of choice. Bloomberg data supports this thesis as net negative supply conditions are expected to intensify this summer with about $150 billion ready to get placed and likely keeping ratios to their currently frothy range.

The stronger longer-end maturities last month likely reflect ongoing demand for longer-dated securities with prospects for higher taxes and heavier reinvestment needs against a backdrop of less prevalent inflationary concerns along the back end of the muni yield curve. We still maintain that compelling market technicals coupled with a favorable credit outlook have the ability to unlock further performance this year. Muni high-yield decidedly outperformed the broader index in April with a return of 1.46%, and is far outperforming the market year-to-date through April returning 3.61%. Muni IG spreads remain tight with frothy, less attractive valuations particularly for higher quality cohorts, interest rates still remain historically low, and the search for yield amid improving credit conditions continues unabated. As concern over rising interest rates mounts, high yield can act as a defensive strategy, yet for many names availability can be challenging. We note that certain sectors are normalizing in terms of spread and are being priced accordingly, yet others remain under pressure as the credit story plays out longer term.

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