Municipal market insight

Wait-and-see mode on munis

Feb 12, 2018

Municipal market highlights

  • Muni bonds declined in January amid rising rates and tax reform disruptions.
  • A strong technical environment continues to drive outperformance vs. Treasuries.
  • We have yet to see enough value restored in the market to make us aggressive buyers.

Market overview

Muni bonds gave back most of their December gains as the S&P Municipal Bond Index fell -0.95% in January amid tax reform disruptions and vastly rising interest rates. (Bond prices rise as rates fall.) Stronger global growth, rising inflation expectations and a shift in sentiment as investors anticipate a global move toward tighter monetary policy coalesced to drive long-term rates higher.

Muni bonds fared better than Treasuries though, given relatively favorable technicals. Muni issuance was $20.6 billion, down -43% as compared to January of last year and -21% versus the five-year average for the month. This came as no surprise because many deals slated for 2018 had been rushed to market (“pulled forward”) before the new tax law took effect, a trend that contributed to the market’s strong performance in December. Retail demand remained remarkably firm, with robust mutual fund flows of $9.9 billion. However, these historically strong technicals were somewhat offset by tax reform disruptions. Dealer inventories were bloated with leftover supply from 2017, and institutional buyers hit the pause button to reassess the relative value of their municipal holdings under the new tax law.

Throughout the month of January, bonds with longer duration (greater sensitivity to interest rate movements) underperformed. However, the downward price pressure on these issues serves to reset their previously rich valuations to more attractive levels going into February. As such, the market may be poised for some relative strength in the near term.

Strategy and positioning

We maintain a defensive positioning given rising U.S. Treasury yields. We have increased cash holdings and we favor short-dated bonds within a barbell strategy. We remain in wait-and-see mode as not enough value has been restored in the market to make us more aggressive buyers.

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 ...

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.