Municipals Deliver on Seasonal Expectations

June update

  • Municipal bonds posted positive absolute and relative performance in June.
  • Modest primary and secondary supply was outpaced by improved demand.
  • While July has historically been a top-performing month, we maintain some near-term caution.

Market Overview

Municipal bonds delivered on expectations for the summer strength and posted positive absolute and relative performance in June. Despite a mid-month pause by the Federal Reserve at the June FOMC meeting, interest rates rose in the front and intermediate part of the yield curve as strong economic data, persistent inflation, and hawkish Fed guidance prompted the market to reprice for a longer tightening cycle. However, improved supply-and-demand technical helped municipals to significantly outperform comparable Treasuries. The S&P Municipal Bond Index returned 0.89%, bringing the year-to-date total return to 2.52%. Longer duration (i.e., more sensitive to interest rate changes) and lower-rated bonds performed best.

The issuance was muted at $36 billion, 8% below the five-year average, bringing the year-to-date total to $171 billion, down 14% year-over-year. As anticipated, the market seasonally transitioned back to net negative supply and benefited from reinvestment income from maturities, calls, and coupons, outpacing issuance by over $2 billion. Deals were oversubscribed by 4.0 times on average, slightly above the year-to-date average of 3.9 times. Similarly, secondary trading was manageable. The bid-wanted activity was slightly elevated at $1.3 billion per day on average but waned modestly as bank portfolio liquidations wrapped up late in the month. At the same time, demand firmed, and the market produced net positive fund flows for the first time since February.

Favorable seasonal technical should aid near-term performance. Historically, July has been a top-performing month, averaging total returns of 1.14% over the past five years. However, some caution is likely still warranted given rich valuations and continued interest rate volatility.

Strategy insights

We maintain a neutral-duration posture overall. We prefer an up-in-quality bias with a neutral allocation to noninvestment grade bonds. We strongly advocate a barbell yield curve strategy, pairing front-end exposure with an increased allocation to the 20-year part of the curve.