March, typically the municipal market’s worst-performing month, surprised to the upside this year. Issuance failed to pick up as expected, which allowed munis to notch a modestly positive return and outperform Treasuries. This marked the fourth consecutive month of positive performance. New issuance of $31.2 billion was 14% below the five- and 10-year averages for March. At the same time, demand for the asset class held on. Monthly inflows of $1.2 billion brought the year-to-date total to $4.9 billion. Flows remained largely concentrated in high yield.
On the credit front, states struggling with pension and budget issues face increased pressure from the rating agencies. New Jersey saw another downgrade due to pension underfunding, and Illinois was warned of the potential for a multi-notch downgrade if it fails to implement a budget during the current legislative session. Such an outcome would make Illinois the first state to be rated non-investment-grade.
We remain constructive on munis given their important role as portfolio diversifiers, as well as their historically low volatility, high credit quality and ability to provide tax-free income. While lower tax rates may erode some of the value of munis’ tax-exemption, its elimination is unlikely. We maintain a neutral duration stance and a preference for lower-rated investment-grade credits, the revenue sector and flexible mandates with the ability to be nimble around interest rate and policy uncertainty.
Long duration outperformed the short to intermediate portion of the curve for the first time since the November election.
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