Andrei Dodonov
Tim Spitz, Head of Technique and Municipal Enterprise Growth | Mark Parris, Chief Funding Officer, Head of Municipal Methods, Invesco Fastened Earnings
To date in 2024, the municipal bond market and most fastened earnings devices haven’t carried out in addition to many anticipated at the start of the 12 months. The tumultuous rally in late 2023 was seemingly too fast and sharp, primarily based primarily on expectations of a number of Fed charge cuts in 2024. A shock improve within the Shopper Worth Index (CPI) information within the first quarter lowered these expectations and by April, bonds turned unfavourable. .
This pullback might have created an attention-grabbing entry level for muni traders. We have additionally simply entered a traditionally sturdy seasonal interval for munis, which generally begins in Could and runs by way of August. Muni market efficiency through the summer season months has typically been optimistic (see chart beneath). Bloomberg The municipal bond index has produced a optimistic whole return yearly since 2015 aside from 2022 and 2023. Taking a look at returns by month, July returns have been optimistic yearly since 2013, even in years with outflows comparable to 2015 and 2022. Whole returns in June and August have been blended.
In the summertime months, the indications of the municipal market have been typically optimistic. The Bloomberg Municipal Bond Index has produced a optimistic whole return yearly since 2015 aside from 2022 and 2023.
In 2024, principal repayments and coupon funds are estimated to whole about $230 billion between Could and August, whereas issuance is forecast to succeed in solely about $160 billion.1 This massive supply-demand imbalance needs to be a tailwind for muni traders. We count on these extreme technical circumstances to permit Muni’s credit score spreads to shrink additional.
As well as, the market is presently pricing in a better chance of a charge reduce by the Federal Reserve (Fed) in September, which seems to have began a rally in Treasury charges. That needs to be welcome information for muni traders as we head into the summer season months.
Municipal lending fundamentals stay sturdy
Municipal loans basically proceed to stay in good elementary situation. Funds from federal pandemic aid and wholesome tax collections proceed to bolster stability sheets, whereas fiscal restraint ought to assist maintain most loans sustainable. In 2023, Moody’s Traders Service and S&P World Rankings upgraded greater than 1,400 credit score rankings and downgraded lower than 350 — a mixed improve/downgrade ratio of 4 to 1. We proceed to consider that, collectively, municipal credit score is the strongest general time
Whereas such a unprecedented charge of upside versus draw back is unlikely to be sustainable, we nonetheless count on comparatively secure credit score high quality in 2024 and no important improve in defaults. That sentiment performed out within the first quarter of 2024, when S&P upgraded 93 credit and downgraded 38. Moody’s was much less bullish, upgrading 153 credit versus downgrading 79. Mixed, that is barely higher than a 2-to-1 improve/downgrade ratio. It is not as sturdy , as in 2023, however continues to be a optimistic sign for the financial market and traders.
In line with ranking companies, the driving power behind the excessive charge of ranking upgrades is the energy of the US economic system and the stable funds of municipal issuers. Income sources for municipalities, comparable to gross sales, property and private earnings taxes, are doing properly, and most municipalities have cautiously managed the inflow of federal stimulus {dollars} tied to the pandemic. At Invesco, our skilled, devoted workforce of 23 professionals has seen the same pattern in growing our inside rankings. Our workforce internally ranks every place we maintain and gives forward-looking suggestions to assist our portfolio workforce decide the risk-reward profit, or lack thereof, of every firm.
We’re paid to attend
The year-to-worst (YTW) yield on the Bloomberg Municipal Bond Index in April 2024 was 3.78%. Previous to the present cycle of Fed hikes, it final reached this stage in April 2011. Even on the top of the pandemic, the YTW index peaked at 3.52% in March 2020. It is necessary to notice that muni bond curiosity is usually exempt from federal earnings taxes, so the muni bond tax-equivalent yield is 3.78% for traders within the tax bracket disclosure to point out the way you got here up with the tax-equivalent quantity.2 For these prepared to tackle further danger, the 5.66% YTW as of April 30, 2024 on the Bloomberg Municipal Excessive Yield Index could also be much more compelling. Though yields briefly peaked through the pandemic, we had to return to July 2017 to see comparable ones.
The underside line: We do not know when the Fed will begin reducing charges. Now we have judgments primarily based on present information, however just like the Fed, they’re information dependent and information is consistently altering. Happily, whereas we await the info to immediate the Fed to chop charges, which ought to assist muni efficiency, we predict we’re getting a stable return for the wait that we have not seen in years.
Footnotes
- Supply: Bloomberg LP, as of April 30, 2024.
- Sources: Bloomberg LP, US Inside Income Service and Invesco as of April 30, 2024.
Now’s this a very good entry level for muni bond traders? by Invesco USA