Opportunities For The Discerning Muni Bond Buyer

Bond market volatility continues to challenge fixed income returns. For now, municipal bonds are struggling, seemingly to no avail, to recover from the record losses booked in January with efforts to outperform UST month-to-date. As we consider municipal bond performance, there is certainly plenty of red, although the losses being posted for UST securities are almost double the negative returns currently being earned month-to-date by munis. Year-to-date, the losses are more closely aligned, with munis modestly outperforming Treasuries. While February seems to reveal less pain for munis compared with the January bloodletting, the near-term outlook will be shaped by investor sentiment and easing fears over Central Bank policy should they emerge. In sharp contrast to 2021, the muni market has witnessed outsized withdrawals from mutual funds at levels not seen since March 2020. For some time now, we have been telegraphing an uneven and uncertain pattern of fund flows and at the very least, we are not surprised by the more visible intermittent outflows, highlighted by high yield and ETF reductions. Until more certainty and stability return to the markets, which admittedly could take some time, we expect to see continued episodic outflows. But again, even though we do not foresee the consistently active deposits of 2021, we are not expecting an extended period of sustained and swelling cash withdrawals from mutual funds.

To say the least, muni participation has been tentative across both the retail and institutional buyer base as well as with primary market interest where many deals have been listed as day-to-day. Since the beginning of January, 10 and 30-year MMD benchmark muni yields have advanced by 63 basis points and 55 basis points respectively. At these higher entry points, there is retail emergence, but again with a very selective bias with respect to structure and we would argue for a cautious and thoughtful deployment of cash. The institutional business has also been muted given the range of unknowns. In addition to increasingly higher rates, the intensifying geopolitical risk has given corporate buyers much pause. Security selection and appropriate valuations have become key to the investment calculus, particularly with the more desirable ratio valuations coming back closer in line with historical averages, thus providing investment opportunities at certain rating levels.

Higher quality and premium bonds can provide investors with a defensive bias as interest rates trend higher. Perhaps the pace of the bond market sell-off is ebbing, yet we do see more runway for munis to outperform UST and corporate securities. For now, we remain committed to our initial call of modestly positive performance for munis by year-end, yet we are mindful that out-sized disruptions in the Treasury market could upend our outlook and catalyze more systemic outflows. At the heart of the resiliency backdrop is a favorable credit profile for munis that is likely to improve further as well as what we expect to be a constructive technical environment.

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