Municipal bond market performance has been undeniably uninspiring during April and May. The total return for the Barclays Municipal Bond Index has actually turned negative (-0.02%) year-to-date, according to Barclays, as of this writing. Some of the central culprits are:
- Elevated forward monthly supply of some $13 billion to $16 billion, which is meaningfully above the 2015 average, so far this year, of $11 billion according to the Bond Buyer
- Sputtering cash flows into ETFs and mutual funds post-tax date
- Uncertainty over how soon the Federal Reserve (Fed) will raise rates
- Certain obligations of the city of Chicago being marked to below investment grade on the heels of the Illinois Supreme Court’s decision to overturn the 2013 Pension Reform Law
Despite a strong first quarter, investors seem to have tempered their desire to further engage municipals, perhaps waiting to see what more evidence there is to support the Fed’s looming rate movements. While investors were pausing, however, the yield curve has shifted to higher levels and I believe the opportunity to reengage the market at better entry points is currently at hand.
The following data points support my general thesis that the fundamentals are still favoring investors. Near term, or until it is certain that the Fed will move rates, it would appear that the greater risk might be that of no action as opposed to a continued commitment to the asset class. As the tables below demonstrate, a significant amount of cash will be available for reinvestment in June, suggesting the potential for improved performance of the asset class.
Finally, the benefit of the tax-free coupon, in my view, greatly enhances the income component of municipals versus corporates or Treasuries. Investors should keep in mind that when the ratio of municipal yields is equal to or exceeding that of Treasuries, there is a potential opportunity for investors.
Source: Bloomberg as of 5/21/2015.