Making The Case for Municipal Bonds Despite Recent Volatility
The first half of the year has so far been challenging for investors in municipal bonds. Ben Barber, Director, Municipal Bonds, Franklin Templeton Fixed Income, shares his latest outlook and reasons for optimism.
After a rocky start to the year in US municipal bonds, investors have not seen a reprieve as the second quarter of the calendar year started off with more of the same volatility. Yields have continued to move higher, roughly 166 basis points (bps) from the start of the year.1 This has caused much of the downward price pressure on the sector and is being exacerbated by heavy outflows from retail investors.
The municipal market will continue to be pressured by the Federal Reserve’s (Fed’s) monetary policy that is aimed at helping to stem inflation as well as those inflationary pressures continuing to drive longer-term yields higher. As we have previously highlighted when providing updates on the municipal market, we will provide outlook for three important dynamics across the sector: technicals, fundamentals and valuations.
Technicals show no sign of changing course in the short term after 15 straight weeks of muni outflows.2
- We believe muni-market volatility will remain elevated with continued monetary policy tightening, even with the 50 bp rate hike at the May Fed meeting. If yields stabilize, the lower volatility could potentially support the municipal market.
- As noted below, investors are beginning to take notice of the attractive valuations and tax-free income potential. We just haven’t seen that en masse to this point.
- A tightening of new issuance in the upcoming weeks will likely help to slow down the supply/demand imbalance created in the most recent quarter. In our view, the summer reinvestment period may help offset outflows as money will likely need to be put to work in the market.