The Week in Muniland

Following a challenging March and a subsequent rebound to start April, the muni market was relatively range-bound for most of the week before rallying to close out Friday. Two-year AAA yields rose 2 basis points (bps) while 10- and 30-year AAA yields fell 4 bps. The Bloomberg Municipal Bond Index (the Index) returned 0.32% last week, bringing month-to-date returns to 1.46%. Year-to-date returns now sit at 1.28%.

• Why it matters: Relative performance versus US Treasuries was mixed. Short maturity after-tax spreads widened up to 8 bps as front-end valuations had become somewhat expensive. Intermediate maturity after-tax spreads were relatively unchanged, while longer maturities tightened modestly over the week. The market did see outflows totaling $408 million last week, according to Lipper. However, those outflows were clearly tax-related, with short-term funds seeing $533 million in outflows, while longer-term funds saw slight inflows. Outside of a single week in March, municipal fund flows were positive nearly every week out of the last 20, and we believe inflows will resume in the following weeks given the strong performance and resiliency of the market this month. This week’s calendar should be relatively manageable—roughly $11 billion is expected to price, but within that, there is only approximately $8 billion of negotiated deals.
  
  

Municipal credit continues to perform well, with the Bloomberg Municipal High Yield Index returning 2.27% this year, outperforming the investment-grade Index by nearly 100 bps.

• Why it matters: Outperformance can broadly be attributed to a few factors. First, a portion of this outperformance is a reflection of the income advantage embedded in lower-rated bonds. That carry provides a meaningful head start and reduces the need for spreads to tighten materially in order to generate excess returns versus higher-quality bonds. For comparison, the Bloomberg Muni High Yield Index currently yields 5.53% and offers nearly 200 bps of yield pickup compared to the investment-grade Index. We have also seen high-yield spreads tighten modestly this year, which has added price appreciation on top of the income pickup versus investment-grade bonds. The high-yield portion of the market has benefitted from a strong technical backdrop, with high-yield funds continuing to see inflows this year, which historically has been an important factor for spread-tightening. Despite the outperformance this year, lower-rated municipals continue to look attractive relative to their corporate counterparts. For example, the Bloomberg Municipal High Yield Index currently sports a 9.34% taxable-equivalent yield versus the 6.75% yield of the Bloomberg US Corporate High Yield Index. Furthermore, the Bloomberg BBB Municipal Index offers a 7.48% taxable-equivalent yield compared to the 5.17% of the Bloomberg BBB US Corporate Index.
  
  

The muni market offers multiple options for investors to capitalize, regardless of their risk profile.

• Why it matters: For more risk-averse investors, while after-tax spreads on the front end of the curve are certainly not cheap, short-maturity munis still offer a compelling yield pickup versus cash, with the 2.71% yield to worst of the Bloomberg 3-year Municipal Bond Index offering over 53 basis points of yield pickup after tax versus 3-month Treasury bills. Investors with longer time horizons can look further out the curve, where higher absolute yields (Display 1) may provide an attractive tax-exempt income stream. Within that, a barbell maturity structure, assuming a roughly six-year duration profile, will likely provide a higher yield (3.53%) compared to a concentrated (3.37%) or laddered (3.43%) maturity structure. This barbell structure may also provide a higher total return profile over time as it takes advantage of the 15- to 20-year spot on the curve, which currently maximizes yield plus roll (Display 3).