This has been a historical year in fixed income, and municipals are no exception. Yields rose dramatically this year in anticipation of Fed moves, as the market is trying to get ahead of the Fed as the Fed is trying to tame inflation. Municipal yields have jumped more than we would’ve anticipated this year, for a couple of reasons.
The largest reason being outflows in the municipal market. That’s another record that was set, and that just forces bond managers to need to sell—and when there’s more supply, that drives up yields. Municipal yields have jumped more than Treasury yields have.
But looking forward, here’s a takeaway. You do not expect yields to move the same amount that they have for the first six months of the year—for the last six months of the year.
When you see big swings in the Treasury market, municipals—over time—will follow that swing, whether it’s up or down. There is an impact to the municipal market from a rate perspective. Although municipals tend to be less volatile in rising rate environments, they have been a little bit more volatile this year because of those outflows that I mentioned earlier.
That movement higher in yields in a brief period of time has impacted bond portfolios, and there was nowhere really to hide—whether you’re in AAA rated bonds, BBB, high-yield or short bonds, long bonds, there’s varying degrees. But all bonds have been negatively impacted because of the sharp moving yields.
But one thing that I’d like to remind investors of [is] that if your time horizon is longer than the duration of your portfolio, you want yields to rise. You’re begging yields to rise.
From an entry point perspective, investors should look at the municipal market as [if] it’s on sale. From a fear perspective—because there are still investors out there that are not opportunistic or they are still a little fearful—even if we run into a recession, let’s say that, if we run into a recession, municipal bonds are a flight to quality—second to Treasuries.
The market is clearly concerned about a recession. We’re not 100% certain there will be a recession. Although, if it does happen, it’s likely going to be a shallow type of recession. Think of a recession like 2001. 2008 was a deep recession, but generally speaking, municipal bonds [and] high-grade bonds perform well in recession.
There are certain sectors within the high-yield market—if you will, the credit side of the market—that perform well in recessionary environments, such as charter schools, housing bonds—[including] certain types of housing bonds, like low-income housing or moderate income. Those are just a couple of examples, but there are ways to protect portfolios in advance of a recession if one were to come.
Is it a good time to buy bonds today? It’s a better time today than it was six months ago. Is today the bottom of the market? I can’t tell you it’s the bottom, but looking forward, the return expectations are so much greater than they were just six months ago.
Daryl Clements is Portfolio Manager of Municipal Bonds at AB.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to change over time.