Municipal market insight

Muni bonds buck the trend

Jul 9, 2018

Municipal market highlights

  • Munis posted positive results in June, typically the market’s third-worst month.
  • Issuance remains muted post tax reform while demand remains remarkably firm.
  • Valuations have slightly improved and typical summer strength may provide a boost.

Market overview

Muni bonds rewarded investors with an unexpected positive return in June (+0.13%), against the odds that a stark pickup in supply would saturate the market as history suggests for this time of year. The market’s persistently strong technical environment provided solid footing for muni bonds to benefit from interest rates remaining range-bound amid geopolitical uncertainty and mounting fears around the impact of international trade wars. (Bond prices typically move inversely with interest rates.)

Issuance continues to be depressed in 2018 as a result of tax reform (which eliminated the exemption for advanced refunding bonds), down 19% year-to-date versus the same period last year and remaining below the 5-year average. The reinvestment of payouts from calls, coupons and matured bonds outweighed gross supply in June, driving prices higher. The benefits of this net negative supply environment were slightly mitigated by activity in the secondary market, where dealer inventories remain bloated.

Demand has remained firm, with eight consecutive weeks of mutual fund inflows since the tax-time surge in short-term fund selling. Short and intermediate term issues outperformed longer term bonds in June. High yield muni bonds were among the stronger performers of the month, led by Puerto Rico and tobacco bonds. Prerefunded bonds and New Jersey issues also provided generous returns for the month.

Outlook

Heading into the late summer months, historically a period of net negative supply following the spring supply push, we hold a positive view on the muni market, particularly as relative valuations have reset to slightly more attractive levels. Looking further ahead into the fall, we anticipate taking a bit more caution as we watch for event risks relating to a potential third Fed rate hike, midterm elections, and the curtailment of the tax benefit for pension buyers.

Strategy and positioning

As valuations have become slightly more attractive and historical seasonal trends suggest favorable conditions are around the corner, we’ve shifted to a slightly longer-than-neutral stance on duration (interest rate risk) while maintaining a barbell yield curve strategy. We prefer lower-rated investment grade credits and revenue bonds for their ability to provide income, and we remain neutral on high yield.

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 ...
James Schwartz, CFA
Head Credit Research Analyst, Municipal Credit Research
Jim Schwartz, CFA, Managing Director, is Head of Municipal Credit Research within BlackRock's Global Fixed Income group. He is a member of BlackRock's Municipal ...
Sean Carney
Municipal Strategist, BlackRock Investment Strategy Team
Sean Carney, Director, is the Head of Municipal Strategy within BlackRock's Global Fixed Income Group, one of the largest managers of U.S. municipal bond ...

To obtain more information on the funds including the Morningstar time period ratings, please visit: Strategic Municipal Opportunities Fund, National Municipal Fund, High Yield Municipal Bond Fund, California Municipal Opportunities Fund, New York Municipal Opportunities Fund, New Jersey Municipal Fund, Pennsylvania Municipal Opportunities Fund.

The Morningstar RatingTM for funds, or "star rating," is calculated for managed products (including mutual funds, variable annuity and variable life subaccounts, exchange-traded funds, closed-end funds, and separate accounts) with at least a three-year history. Exchange-traded funds and open-ended mutual funds are considered a single population for comparative purposes. It is calculated based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a managed product's monthly excess performance, placing more emphasis on downward variations and rewarding consistent performance. The top 10% of products in each product category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars, and the bottom 10% receive 1 star. The Overall Morningstar Rating for a managed product is derived from a weighted average of the performance figures associated with its three-, five-, and 10-year (if applicable) Morningstar Rating metrics. The weights are: 100% three-year rating for 36-59 months of total returns, 60% five-year rating/40% three-year rating for 60-119 months of total returns, and 50% 10-year rating/30% five-year rating/20% three-year rating for 120 or more months of total returns. While the 10-year overall star rating formula seems to give the most weight to the 10-year period, the most recent three-year period actually has the greatest impact because it is included in all three rating periods.

Performance data quoted represents past performance and is no guarantee of future results. Investment returns and principal values may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. All returns assume reinvestment of dividends and capital gains. Current performance may be lower or higher than that shown. Refer to blackrock.com for most recent month-end performance.