Municipal bonds staged a comeback in July, even in the face of Puerto Rico related angst, ending a three-month performance drought. A rally in the U.S. Treasury market was a key tailwind. Uneven economic data cast doubt on the Fed’s ability to begin a rate-hiking cycle this fall, and that led to falling rates (higher prices) and a flatter yield curve.
Another contributing factor was the emergence of a more favorable supply/demand dynamic. New municipal issuance for July came in at a historically normal $30.8 billion and in a wide variety of credits and structures, while demand was reasonable. Puerto Rico-induced outflows dominated early in the month, but gave way to inflows by month-end. In all, July saw $676 million in outflows, bringing year-to-date flows to $7.8 billion. Munis still offer a positive investment case, but we are cognizant that crossover buyers (taxable investors) have more investment choices as corporate bond prices cheapen. As such, we expect a traditional retail buyer base to drive the market in the near term.