Although fewer municipal bonds are being issued, yields have reached levels not seen in more than a decade.
How is that possible?
Last month, municipal bond issuance plunged more than 40% compared to the same time last year. October’s volume was $24.5 billion and 510 issues compared with $41.81 billion and 1,068 issues in October 2021.
So far this year, total issuance has dropped 15.9% from 2021, to $339.6 billion.
With shrinking new supply, investors might naturally think prices, which move inversely to yields, would rise. Yet they haven’t.
So where is the supply coming from that is buoying yields?
Investors selling their municipal bond mutual funds.
Scooping up value
After about $100 billion of record-setting inflows into muni mutual funds last year, investors did an about-face in 2022.
Stoked by inflation concerns and the Federal Reserve Board’s efforts to raise short-term rates, outflows from funds so far this year have reached about $70 billion.
As issuance slumped, then, fund investors streaming to the muni fund exits have kept the market well stocked. This has enabled investors of individual bonds to reap taxable-equivalent yields of 6.90% on AA-rated insured 30-year bonds, while the taxable-equivalent AA-muni-to-Treasury ratio recently stood at a stratospheric 162%.
As we’ve noted, the selloff was driven by fear, not credit quality (“The Ballast Behind the Muni Market”).
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Local and state governments are, generally, in good fiscal shape. In fact, they’ve fortified their finances since the gloomy forecasts of economic distress from the pandemic were never realized. This year, credit-quality upgrades have exceeded downgrades by a 3-to-1 margin, according to Barron’s.
Long end sought by muni investors
Of course, the circumstances around the current market won’t last forever.
Higher short-term rates usually lead to lower long-term rates as the economy cools, which is the Fed’s ultimate aim.
For now, though, exceptional value exists in the long-end of the market – the focus of municipal bond investors.
For months, investors were pummeled with news about the bond market selloff and disturbed by the market value of their holdings when they glimpsed their statements every month.
But for those staying the course, it’s been a rewarding year so far. They’ve kept their stream of tax-free income flowing and strategically taken advantage of unique opportunities.