The Week in Muniland

The muni market was down for the week due in large part to rate volatility but nevertheless outperformed US Treasuries (UST). Two-, 10- and 30-year AAA yields rose 10, 5 and 6 basis points (bps), respectively. The Bloomberg Municipal Bond Index (the Index) returned –0.35% last week, bringing April returns to 1.15%. Year-to-date returns now sit at 0.97%.

• Why it matters: A busy economic reporting calendar and rate volatility resulted in a down week. However, net inflows were positive, totaling $615 million, which raised year-to-date (YTD) net inflows to $29.5 billion. Of YTD inflows, 53% have gone into long bonds and 13% into high yield. Issuance has also been supportive, with high yield representing only 6% of total issuance, while bonds longer than 10 years represent only 22%. This high level of support is a significant reason why these subsets of the muni market have been the best performing. As seen in Display 1, longer bonds have significantly outperformed intermediate- and shorter-maturity bonds. High-yield bonds have been the other bright spot, with the Bloomberg Municipal Bond High Yield Index up 2.13% YTD, compared to 0.84% for the Bloomberg AAA muni index. We have recommended, and continue to recommend, owning both long-maturity bonds and high yield as part of an overall municipal bond allocation.
  
  

In our opinion, actively managing a muni bond portfolio is far superior to taking a passive approach. Don’t take our opinion. Look at the data.

• Why it matters: We make that statement without an axe to grind. We manage both active and passive strategies, although we do lean toward active. According to Morningstar data, active muni strategies outperform passive strategies +97% of the time over rolling three-year periods; 75% would be astounding, let alone over 97%. This year is a microcosm of this outperformance. Assuming a duration-neutral approach and using Bloomberg index data, an active barbelled approach is outperforming a passive laddered approach. Assuming a 5.9-year duration, a barbell is yielding 3.64% with a return of 1.38%, versus a ladder yielding 3.53% with a return of 0.91%. The reason for the outperformance this year is the ability of an active manager to take advantage of a very steep yield curve (Display 2) and add credit where appropriate. In addition, managers that have the ability to invest in USTs when munis become too expensive, as they were in February (Display 3), can add additional value as munis eventually move back toward fair value. In a market of over 1 million CUSIPs and 50,000 issuers, there is plenty of opportunity if you know where to look.
  
  

The Federal Open Market Committee (FOMC) left its target interest rate unchanged at 3.50%–3.75%, as had been unanimously expected.

• Why it matters: Given the uncertain impact of the war in Iran on both growth and inflation, the Fed remains in wait-and-see mode, a point made both in the statement accompanying the rate decision and in Chair Powell’s press conference. We anticipate that the Fed will leave rates unchanged for the next several months at least, barring a dramatic change in the economic data. There were three dissents to the Fed’s statement. Those members dissented in favor of a statement that does not have an easing bias in it. We interpret those dissents as making clear that those members of the FOMC will not be willing to vote for rate cuts any time soon, barring a dramatic deterioration in the labor market. That’s a signal to incoming Fed Chair Kevin Warsh that he should not expect the committee to start cutting rates immediately—which we were not anticipating in any event.