Municipal market insight

Tough times for muni bonds

Nov 7, 2018

Municipal market highlights

  • Rising interest rates and volatility are challenging bond markets broadly.
  • Municipals saw higher net issuance and a pullback in retail demand in October.
  • We are cautious given supply-demand dynamics and upcoming tax loss selling.

Market overview

October was a difficult month for bond markets broadly. Interest rates moved higher in response to Federal Reserve Chairman Powell suggesting a continued commitment to normalizing policy given the view that rates still remain accommodative. (Bond prices and interest rates generally move inversely to each other.)

The S&P Municipal Bond Index declined -0.66% over the month, dragging year-to-date performance further down to -0.82%. High yield and long-maturity bonds were the weaker performers, while losses were minimal in short-term bonds, as well as higher credit quality and prerefunded bonds.

Supply materialized as expected in October with gross issuance of $34.8 billion, down 12% year-over-year, which is broadly in line with the -14% run rate thus far in 2018. Net of redemptions, issuance was $8.8 billion, the second largest monthly net issuance this year, posing a headwind for performance. This dynamic was met with weakening demand as retail fund flows continued to be negative amid rate volatility.

Outlook

Our outlook for the muni market continues to be cautious until the technical environment improves. It is possible that demand could strengthen as volatility normalizes and rates settle in at their new, higher range; however, we are entering a period of seasonally weak demand driven by year-end tax loss selling (i.e., investors sell positions to harvest losses that can offset capital gains).

Strategy

We moved to a shorter duration stance with respect to municipal bond positioning given less favorable supply-and-demand dynamics, while tactically using hedges to adjust overall duration and capitalize on interest rate volatility. We continue to maintain a barbell yield curve strategy, with concentrations in the 0-2 and 20 years + segments. We prefer lower-rated investment grade credits, revenue bonds, issues in high tax states and the transportation sector.

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 ...
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Strategic Municipal Opportunities Fund
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New York Municipal Opportunities Fund
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Pennsylvania Municipal Opportunities Fund

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