- Demand outpaced supply and prompted strong absolute and relative performance.
- Rich valuations and waning seasonal trends warrant some near-term caution going forward.
- Any prolonged weakness would offer the opportunity to add duration and lock in attractive yields.
Municipal bonds maintained their seasonal strength and extended gains for the second consecutive month in July. Interest rates rose amid heightened volatility as economic data exceeded expectations, and the Federal Reserve resumed its tightening cycle and communicated a commitment to data dependence. Favorable supply-and-demand dynamics and the more stable nature of the asset class prompted outperformance versus Treasuries. The S&P Municipal Bond Index returned 0.25%, bringing the year-to-date total return to 2.78%. Triple-B-rated credits and the 15-year part of the yield curve performed best.
Issuance totaled just $27 billion, 17% below the five-year average, bringing the year-to-date total to $198 billion, down 12% year over year. Reinvestment income from maturities, calls, and coupons outpaced issuance by nearly $16 billion and created a favorable net-negative supply environment. As a result, deals were oversubscribed by 5.2 times on average, well above the year-to-date average of just 4.0 times. The bid-wanted activity also underwhelmed, falling over $300 million per day, month over month, as bank portfolio liquidations ceased in late June. Concurrently, demand for the asset class has continued to strengthen. Mutual funds experienced increasingly positive fund flows, while professional retail accounts were inundated with new orders.
We believe that rich valuations and waning seasonal technical warrant a bit more caution in the weeks ahead. Performance tends to soften in August as the market prepares for increased supply in the autumn. However, we would view any prolonged weakness as an opportunity to add duration and lock in attractive, late-cycle yields.
We maintain a neutral-duration posture overall. We prefer an up-in-quality bias and have become increasingly selective in the non-investment grade. We strongly advocate a barbell yield curve strategy, pairing front-end exposure with an increased allocation to the 15-20-year part of the curve.
- Essential-service revenue bonds.
- Select the highest quality state and local issuers with the broadest tax support.
- Flagship universities.
- Select issuers in the high-yield space.
- Speculative projects with weak sponsorship, unproven technology, or unsound feasibility studies.
- Senior living and long-term care facilities in saturated markets.
- Lower-rated private universities.
- Stand-alone and rural health providers.