Highlights

  • 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."

Overview

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.

Index returns are for illustrative purposes only.  Index performance returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of February 4, 2014, and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. There is no guarantee that any forecasts made will come to pass. Any investments named within this material may not necessarily be held in any accounts managed by BlackRock. Reliance upon information in this material is at the sole discretion of the reader.

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