October was a poor month for interest rates that spilled into the municipal market, producing a performance drag that was exacerbated by heavy bond issuance. The broad rise in rates (and coincident drop in bond prices) was driven by a pick-up in inflation expectations and central banks around the world questioning the benefits of negative interest rate policy. This incited concerns that central bankers might back away from easy monetary policies. U.S. election uncertainty added to the unease.
Munis' ability to help diversify a portfolio and provide lower volatility and tax-free income are advantages that remain firmly intact.
Muni bond issuance of $53 billion was much higher than expected, up 57% year-over-year and 41% and 40% above the five- and 10-year averages, respectively. This made October 2016 the largest issuance month since December 1985, when state and local governments rushed to the market prior to the Tax Reform Act of 1986. While supply overwhelmed, demand waned as traditional buyers retreated on the back of recent lackluster performance. That said, September's relative underperformance served to reset relative value measures and this helped munis to draw significant crossover interest, a key factor in the market's ability to absorb the historically robust supply. The market recorded fund flows of $1.66 billion in October.
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