Municipal market insight

Muni bonds hit a speed bump as rates rise

Oct 9, 2017

Municipal market highlights

  • A sharp rise in rates resulted in negative performance for muni bonds in September.
  • The advantages of owning municipals continues to support firm demand.
  • Puerto Rico bonds sold off as the fiscally troubled island suffered hurricane damages.

Market overview

Municipal bonds broadly ticked down in September as interest rates moved sharply higher across the yield curve. (Bond prices fall as rates rise.) Investors shed some of their fixed income holdings in favor of riskier assets as hurricane damages turned out to be less severe than forecasted, the Federal Reserve announced its balance sheet normalization policy and maintained its expectation for a December rate hike, and Republican leaders released their much-anticipated framework for tax reform. Municipal bonds fared better than Treasury bonds due to a favorable supply-and-demand dynamic in the muni market. Muni issuance of $26.7 billion in September was 33% lower than the same month last year, continuing this year’s below-average trend, while demand for the asset class remained firm. The expanded proposal for tax reform did not mention the municipal tax exemption, however, there have been no indications of reduced support. The proposed changes to individual tax brackets pose little threat to the value of municipal bonds on a tax-adjusted basis, and the administration’s intent to further limit deductions would leave muni bonds as one of the few remaining avenues for tax shelter – a positive for demand. From a credit perspective, Puerto Rico and Connecticut are a current focus for investors.

Strategy and outlook

Our stance is more defensive as valuations remain rich while supply is likely to pick up from the summer-time lull. Central bank policy tightening, among other factors, points toward a grind higher in interest rates between now and year end. Nonetheless, the advantages of owning municipal bonds – high-quality, tax-exempt income, low volatility and portfolio diversification – continue to support firm demand. From a strategy perspective, we moved slightly lower in duration, while maintaining a neutral bias. We prefer the A-rated space, longer-dated issues and revenue bonds.

The advantages of owning municipals continues to support firm demand.

Peter Hayes
Head of Municipal Bonds
Peter Hayes, Managing Director, is Head of the Municipal Group within BlackRock's Global Fixed Income group and a member of the Global Fixed Income Executive ...