• The municipal bond market saw positive returns in July after three down months.
  • Puerto Rico headlines, including the commonwealth’s first default in early August, did little to disrupt the broader municipal market.
  • We believe conditions should remain largely positive for August, but recognize that the macro backdrop warrants a neutral duration stance.

"Going back to 2000, positive July performance has typically been followed by a positive August (ex 2007), and in all but two cases, August outperformed July."


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.

The island of Puerto Rico is in over its head—admittedly unable to pay its bills. Peter Hayes looks at what might happen next, including the potential depth of bondholder haircuts.

Investing involves risk, including possible loss of principal.

Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments.

There may be less information on the financial condition of municipal issuers than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. Some investors may be subject to federal or state income taxes or the Alternative Minimum Tax (AMT). Capital gains distributions, if any, are taxable.

A portion of the income may be taxable.

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