Municipal market insight

Tax reform ignites a year-end rally in
muni bonds

Jan 9, 2018

Municipal market highlights

  • Muni bonds delivered robust performance in December despite elevated supply.
  • Tax reform is a net positive for munis, but heightens the need for credit research.
  • Lower issuance in early 2018 should support muni bond prices in the near-term.

Market overview

Muni bonds posted strong returns in December, lifting the S&P Municipal Bond Index 0.95% for the month and finishing the year up 4.95%. The muni and Treasury yield curves flattened as long-term rates fell. (Bond prices rise as rates fall.) But muni bonds strongly outperformed Treasuries as issuers and investors alike prepared for anticipated tax law changes. Muni issuers rushed deals to market ahead of the January 1 effective date given the anticipated elimination of the tax-exemption for advanced refunding bonds and possibly private activity bonds (PABs). Issuance in December was the highest monthly total on record at $55.8 billion, 196% higher than December 2016 and 71% above the month’s 5-year average.

Ultimately, the final version of the Tax Cuts and Jobs Act left PABs unchanged, though the pulling forward of issues in late 2017 is likely to significantly depress supply in early 2018, a sentiment that helped to propel performance late in the month. While the elevated supply was readily absorbed in the primary market, retail demand softened slightly during the month. Municipal bond mutual funds experienced outflows of -$1.3 billion, but this is likely a result of seasonal factors (e.g., investors selling for tax purposes), and muni funds still ended the year up $24.2 billion.

The scaling back of the state and local tax (SALT) deduction should create greater demand in high tax states as muni bonds remain one of the last tax-advantaged investments, but longer-term effects on issuer fundamentals heightens the need for diligent credit research.

Strategy and outlook

While current municipal valuations are far from cheap, the passage of a tax reform bill that is expected to create net negative supply and increase retail demand leaves us constructive on the asset class in the near-term. We moved to a longer duration posture and continue to favor lower-rated investment grade credits and a barbell curve strategy.

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 ...

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 for most recent month-end performance.