Municipal market insight

Muni bonds on the rebound

Jun 7, 2018

Municipal market highlights

  • After rates peaked mid-month, the muni market finished May with strong gains.
  • Issuance is gradually rebounding from early-2018 lows while demand remains firm.
  • We are cautious of a challenging June ahead of typical summer strength.

Market overview

Interest rates were volatile in May, with the 10-year Treasury yield moving north of 3% by the middle of the month to its highest level since 2011. (Bond prices fall as rates rise.) But increased geopolitical uncertainty pushed rates lower by month end, helping the municipal market post strong returns as demand for the asset class recovered from recent seasonal weakness. The broad S&P Municipal Bond Index gained 1.13% in May, bringing its year-to-date return to -0.15%.

The stronger-performing segments included long-duration and lower-rated credits, once again led by the Puerto Rico and tobacco sectors. Illinois bonds also posted strong performance amid increased demand for high yield surrogates coupled with the state’s encouraging progress toward passing its budget.

After five consecutive weeks of tax-time outflows from municipal mutual funds, demand turned positive at the beginning of May and remains firm overall. Muni supply has continued to pick up from the extremely depressed levels seen earlier in the year, but remains below historical norms. That said, the “norm” for issuance is likely to reset lower given the elimination of the tax exemption for advanced refundings.

Outlook

As the month of June kicks off the summer, many investors expect it to be the start of the seasonally favorable period of net negative supply. But in actuality, June has been, on average, the third worst month of the year for muni performance due to a large month-over-month increase in gross issuance. Given the current rebound from the depressed issuance in early 2018, the possibility of a stark pickup in gross supply could pressure muni performance in June ahead of the more favorable July-August period. This dynamic could be further exacerbated should there be a reversal from the late-May decline in interest rates and corresponding rise in muni bond prices.

Strategy and positioning

We maintain a slightly short of neutral stance on duration (interest rate risk) with a barbell yield curve strategy to take advantage of curve steepness, liquidity and improving relative valuations. We prefer lower-rated investment grade credits for their ability to generate income, and we remain neutral on high yield given tight valuations.

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.