Muni bonds outrun rising rates

April 12, 2021

Monthly update

• Municipals posted gains in March despite rapidly rising interest rates.
• Although valuations appear rich, we expect supply and demand dynamics to remain favorable.
• Federal aid to state and local governments should help underpin municipal fundamentals.

Market Overview

While most fixed income asset classes posted negative returns for the month of March, the broad S&P Municipal Bond Index posted a gain of 0.55%. It was a challenging month for bond markets generally as the passage of additional fiscal stimulus and rising optimism for further reopening of the economy drove interest rates higher. (Bond prices fall when interest rates rise.) Municipals, however, rebounded from their temporary value-driven correction of late February. Longer duration and lower credit quality muni bonds were the better performers.

Issuance at $45 billion was 59% above the 5-year average for the month of March. A large and diverse new-issue calendar offered opportunity for investors to put cash to work at attractive levels. As a result, new issues were oversubscribed by 6.5 times on average versus just 4.6x in February. Notably, taxable deals fell to just 19% of total issuance, down from 31% earlier in the year, as higher interest rates made the advance refunding of tax-exempt debt in the taxable municipal market less economical.

After a brief outflow early in the month, retail demand firmed alongside strong muni bond performance. Inflows were led by long-term muni bond mutual funds.

Outlook

Although valuations remain historically rich, we maintain a constructive view on the asset class. Supply is expected to be manageable and the extension of Tax Day should help the market avoid weakness that is typical in April due to investors selling securities to pay tax bills. Additionally, the $350 billion in direct aid to state and local governments provided by the American Rescue Plan should help underpin municipal fundamentals, which have already benefited from better-than-expected revenue collections.

Strategy

We maintain a neutral stance on duration (interest rate risk) within a barbell yield curve strategy. We continue to hold a preference for lower-rated credits and sectors that have been more impacted by the pandemic such as transportation, travel-related (hotel tax, airport, etc.), and health care.

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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.