The Week in Muniland

The muni market rebounded strongly last week, as the broader markets became more encouraged about a resolution for the US-Iran conflict, which drove yields lower across fixed-income markets. Two-, 10- and 30-year AAA yields fell 10, 13 and 13 basis points (bps), respectively. The Bloomberg Municipal Bond Index (the Index) returned 0.82% last week, bringing year-to-date returns to 0.97%.
 

• Why it matters: Not only did yields fall, but the muni market also outperformed US Treasuries last week. After-tax spreads tightened from 10 to 17 bps across the curve, with intermediate and longer maturities seeing the largest outperformance. There was a strong bid for tax-exempts, as the market was focused on putting to work April reinvestment cash and the $866 million of inflows into the market, according to Lipper. Following a lone week of outflows that broke a 17-week consecutive streak of inflows, the market is back to its regularly scheduled programming with back-to-back weeks of inflows and has seemingly made it through the bulk of tax season without material outflow pressure. Year-to-date flows into mutual funds and ETFs now sit at roughly $28.3 billion, which is the second-highest year-to-date total since Lipper began reporting flows. While next week’s headline issuance number of ~$14 billion sounds large, it is headlined by two large taxable deals. Tax-exempt issuance should be far more manageable, with roughly $10 billion expected to price.
   

The muni market has rebounded this month after posting a difficult –2.32% return in March.
 

• Why it matters: March was certainly challenging for muni investors, with the Index return in March ranking as the 11th worst month of performance in the last 20 years, and the third worst March return over the same period. As we have mentioned, March’s volatility was driven by a combination of increased macroeconomic uncertainty that coincided with expensive valuations and an increase in tax-exempt supply. This caused after-tax spreads to widen across the curve. Not only that, but the belly of the curve has underperformed this year, with the Bloomberg 3-Year and 20-Year Municipal Bond Indices returning 0.83% and 1.99% respectively, compared to the 0.29% return of the 10-Year Index. As we look forward, while relative valuations are not quite as attractive as they were a week ago, intermediate and longer maturities continue to offer value from both an absolute income and total return perspective—particularly in the 15-to-20 year part of the curve.
   

US inflation increased in March, rising 0.9% month over month and 3.3% year over year, driven by a 10.9% increase in energy prices. Core inflation was better behaved, up 0.2% month over month and 2.6% year over year.
 

• Why it matters: We view the sharp rise in headline inflation as a function of energy price volatility rather than a deterioration in underlying inflation dynamics, with core inflation continuing to move sideways near a 2.5% run rate. The key uncertainty is the extent to which higher energy costs ultimately pass through to core categories— such as transportation services. At the same time, tariff-related goods inflation appears to have largely worked its way through the system, leaving essential household categories, such as food, rent, education and medical care, as the primary sources of ongoing pressure. Even though there will be an impact to inflation, the potential impact on growth may turn out to be more significant, which is one of the reasons we continue to believe the Fed is more likely to cut rates—rather than raise them—later this year. On the whole, however, the important question is whether the surge in energy prices ends up passing through to core inflation—and it is too early to answer that question. Thus, there are minimal policy implications from this data. The Fed is on hold until there is a clearer picture of how the war affects the economy, from both an inflation and growth perspective.