Municipals outperformed U.S. Treasuries in January as investors returned to the asset class and interest rates remained largely range bound. New issuance of $31.6 billion was up 67% from December’s low and 32% above the 10-year average. We see this as more of an anomaly than a trend. Demand turned significantly more constructive after 10 weeks of post-election outflows. Muni bond mutual funds added $1.1 billion for the month on the back of stronger performance and greater rate stability. Demand came largely from traditional buyers.
Muni investors remain focused on the potential implications of tax reform. While a reduction in tax rates threatens to reduce the value of the municipal tax-exemption, its elimination remains highly unlikely, in our view. We also expect any market correction required to overcome a drop in the highest tax rate or cap on the tax-exemption would be manageable, and continue to believe munis hold an important place in a diversified portfolio.
Given continued uncertainty around the new administration’s policies and the potential for two to four Fed rate hikes in 2017, we maintain our preference for liquidity and flexibility. This leads us to favor short to intermediate maturities, A-rated credits and flexible mandates. Amid volatile rates in 2017, we would view periods of municipal market strength as a time to get defensive and periods of weakness as a buying opportunity.
Volatility is likely, but we would view any weakness as a buying opportunity.
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