Checking the muni market's pulse

Timely insights from portfolio managers and industry experts on key financial, economic and political issues.

The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness.

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      By Michael J. Sullivan, CFA, Institutional Portfolio Manager, Eaton Vance

      Boston - The first quarter of 2019 proved to be favorable for U.S. fixed income markets as initial signs of slowing global economic growth and a patient, data dependent Federal Reserve helped drive yields broadly lower.

      The U.S. municipal bond market experienced three consecutive months of positive performance with the Bloomberg Barclays Municipal Bond Index returning 2.90% over the period. Lower quality municipal bonds outperformed with the Bloomberg Barclays High Yield Municipal Bond Index returning 3.83%. For the quarter, municipal bond yields moved significantly lower primarily due to consistently strong retail demand, fresh concerns about global economic growth and an increasingly dovish tone from the Federal Reserve.

      Municipal bond mutual fund flows were sharply positive in the first quarter. According to the Investment Company Institute (ICI) as of March 20, inflows into municipal bond funds totaled $23.9 billion over the quarter, a strong reversal from the outflows witnessed in the fourth quarter of 2018. Municipal bond issuance totaled $76.5 billion in the first quarter, up 16.8% compared to the first quarter of 2018. Year-to-date net municipal issuance is approximately $1 billion.

      Over the first quarter, 2-year, 5-year, 10-year and 30-year municipal yields decreased by 29, 37, 42 and 42 basis points, respectively. U.S. Treasury (UST) yields also fell, however not as dramatically, with 2-year, 5-year, 10-year and 30-year UST yields declining by 23, 28, 29 and 22 basis points, respectively. As a result, muni-to-Treasury ratios declined (richened) across the curve. The municipal curve remains steeper than the Treasury curve with 111 basis points between the 30-year and 2-year yields, compared to only 51 basis points for the UST curve.

      Lower quality municipal bonds outperformed investment grade municipals in the first quarter. The Bloomberg Barclays High Yield Municipal Bond Index returned 3.83% while the AAA-rated subset of the Bloomberg Barclays Municipal Bond Index returned 2.67%. Continuing the strong performance trend from last year, the Puerto Rico High Yield Municipal Bond Index returned 7.85% in the first quarter.


      U.S. interest rate volatility is likely to persist with markets digesting changing global growth projections, ongoing international trade negotiations and a data dependent approach from the Federal Reserve. For municipals specifically, investors may be cautious due to the strong rally since the end of October. However, we see strong retail demand and a favorable technical backdrop as potential tailwinds for the asset class.

      Municipal-to-Treasury ratios have decreased relative to their 5-year averages, with 5-year, 10-year and 30-year ratios at 70%, 77% and 93%, respectively. On the surface, this may suggest municipals are overvalued. However, since the passage of the Tax Cut and Jobs Act, the market has experienced a noticeable uptick in retail demand and a decline in municipal supply. This development could indicate a new normal, justifying the tighter (richer) muni-to-Treasury ratios for the foreseeable future.

      From an interest rate risk standpoint, we continue to favor the front half of the municipal curve as 85% of the yield available on the entire curve can be captured by extending 15 years. The Federal Reserve has indicated its approach will be data dependent and it has paused rate hikes for the foreseeable future. Investors may consider extending duration, particularly if economic growth and inflation continue to underwhelm in 2019.

      Bottom line: Despite ongoing credit challenges for some high-profile issuers, municipal credit is stable overall. With credit spreads at historically tight levels, we believe discipline and seasoned professional oversight are essential. From an overall portfolio perspective, municipals offer tax-free yield with lower risk, given the lack of correlation to other asset classes. With equity and interest rates exhibiting volatility, municipals may provide welcomed balance to diversified portfolios.