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MARKETS
May 07, 2024

Weekly Municipal Monitor—Spring Slump

By Sam Weitzman
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Municipals Posted Positive Returns Last Week

Top-grade munis posted positive returns yet underperformed Treasuries last week, which moved lower on weaker-than-expected payroll data. Meanwhile, market technicals improved on fund inflows and lower supply conditions. The Bloomberg Municipal Index returned 0.68% during the week, the High Yield Muni Index returned 0.85% and the Taxable Muni Index returned 1.38%. This week we highlight drivers of challenged muni performance during the month of April.

Technicals Improved on Fund Inflows, Lower Supply Conditions

Fund Flows: During the week ending May 1, weekly reporting municipal mutual funds recorded $515 million of net inflows, according to Lipper. Long-term funds recorded $456 million of inflows, intermediate funds recorded $31 million of inflows and high-yield funds recorded $193 million of inflows. Short-term funds recorded $12 million of inflows. This week’s inflows lead estimated year-to-date (YTD) net inflows higher to $9.6 billion.

Supply: The muni market recorded $7 billion of new-issue volume last week, down 52% from the prior week. YTD issuance of $146 billion is 37% higher than last year’s level, with tax-exempt issuance 45% higher and taxable issuance 24% lower year-over-year (YoY). This week’s calendar is expected to jump to $12 billion. Largest deals include $1.8 billion State of Illinois and $947 million University of Chicago transactions.

This Week in Munis: Spring Slump

The municipal market posted negative returns in April as the Bloomberg Municipal Bond Index returned -1.24% for the month, which brought the YTD total return down to -1.62%. Higher-quality and shorter-maturity bonds generally outperformed during the month, while longer-duration maturities experienced the most weakness. AAA rated muni yields1 moved 25-31 bps higher in 2- to 30-year maturities, in sympathy with Treasuries which increased due to stronger-than-anticipated inflation and labor data.

Exhibit 1: Bloomberg Muni Index Returns—2024 vs. the 10-Year Average
Bloomberg Muni Index Returns—2024 vs. the 10-Year Average
Source: Bloomberg Municipal Bond Index. As of 30 Apr 24. Select the image to expand the view.

Municipal supply and demand technicals were relatively weak and contributed to the negative tone in April. Total municipal issuance reached $45 billion during the month, 18% higher than March levels and 30% higher than April 2023. YTD new-issue supply of $146 billion was 34% higher YoY, with tax-exempt issuance rising by 44% and taxable issuance falling by 23%. Tax-exempt issuance has comprised 91% of YTD issuance, and has been bolstered by the refunding of taxable debt into the tax-exempt market.

Exhibit 2: Municipal Supply—2024 vs. the 5-Year Average
Municipal Supply—2024 vs. the 5-Year Average
Source: Bloomberg, Western Asset. As of 30 Apr 24. Select the image to expand the view.

Municipal demand was fairly muted in April, as Lipper reported a modest $8 million of net outflows, with Long-Term and High-Yield funds recording inflows, while Short and Intermediate categories experiencing outflows. Municipal mutual funds have recorded $9.6 billion of inflows YTD.

The seasonally negative spring performance has contributed to relatively higher municipal yields and tax-exempt income opportunities. The average yield-to-worst of the Bloomberg Municipal Index has increased by 0.55% YTD, reaching 3.77%, equivalent to 6.37% on a taxable-equivalent basis for an investor in the highest marginal tax bracket. However, Western Asset considers the relative valuations within the municipal index to be bifurcated. Strong recent demand for high-grade SMA products has led to relatively tight valuations in the highest-quality segment of the municipal market, while lower investment-grade credits present more attractive after-tax valuations compared to corporate bonds.

Exhibit 3: After-Tax Yield Pickup by Quality Cohort
After-Tax Yield Pickup by Quality Cohort
Source: Bloomberg, Western Asset. As of 03 May 24. 10- and 30-Year comparison reflects Bloomberg Valuation Service (BVAL) AAA Muni Curve and US On-/Off-the-Run Sovereign Curve. AA Muni reflects the Bloomberg AA Muni Bond Index. A Muni reflects the Bloomberg A Muni Bond Index. BBB Muni reflects the Bloomberg BBB Muni Bond Index. HY Muni reflects the Bloomberg High Yield Muni Bond Index. AA Corp reflects the Bloomberg AA Corporate Bond Index. A Corp reflects the Bloomberg A Corporate Bond Index. BBB Corp reflects the Bloomberg BBB Corporate Bond Index. After-tax yield considers top marginal tax rate of 40.8%. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results. Select the image to expand the view.

Municipal Credit Curves and Relative Value

Exhibit 4: Muni Credit Curves
Muni Credit Curves
Source: Bloomberg, Western Asset. As of 03 May 24. Bloomberg BVAL Municipal Credit Indices (AAA, AA, A, BBB, respectively) and US Sovereign Curves. Taxable-Equivalent Muni Credit Curves consider the top marginal effective tax rate of 40.8%. Select the image to expand the view.
Exhibit 5: Taxable-Equivalent Muni Credit Curves
Taxable-Equivalent Muni Credit Curves
Source: Bloomberg, Western Asset. As of 03 May 24. Bloomberg BVAL Municipal Credit Indices (AAA, AA, A, BBB, respectively) and US Sovereign Curves. Taxable-Equivalent Muni Credit Curves consider the top marginal effective tax rate of 40.8%. Select the image to expand the view.
Exhibit 6: AAA Munis versus Treasuries
AAA Munis versus Treasuries
Source: Muni Yields: Thomson Reuters MMD, Treasury Yields: Bloomberg. As of 03 May 24. Past performance is not a guarantee of future results. It is not possible to invest directly in an Index. Select the image to expand the view.
Exhibit 7: Tax-Exempt and Taxable Muni Valuations
Tax-Exempt and Taxable Muni Valuations
Source: Bloomberg. Yield-to-worst (YTW) is the lowest potential yield that can be received on a bond without the issuer actually defaulting. As of 03 May 24. Select the image to expand the view.

Western Asset Key Themes for Muni Investors

Theme #1: Municipal taxable-equivalent yields are above decade averages.

Exhibit 8: Muni and Taxable-Equivalent Muni Yield-to-Worst
Muni and Taxable-Equivalent Muni Yield-to-Worst
Source: Bloomberg, Western Asset. As of 03 May 24. Bloomberg Municipal Bond Index Yield Considering Highest Marginal Tax Rate of 40.8%. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results. Select the image to expand the view.

Theme #2: The inverted yield curve suggests less relative value in 5- and 10-year maturities.

Exhibit 9: AAA Municipal vs. Treasury Yield Curves
AAA Municipal vs. Treasury Yield Curves
Source: Bloomberg, Western Asset. As of 03 May 24 Bloomberg Valuation Service (BVAL) AAA Muni Curve and US On-/Off-the-Run Sovereign Curve. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results. Select the image to expand the view.

Theme #3: Munis offer attractive after-tax yield pickup versus long Treasuries and corporate credit.

Exhibit 10: Municipal vs. Taxable Fixed-Income Yields by Quality
Municipal vs. Taxable Fixed-Income Yields by Quality
Source: Western Asset, Bloomberg. As 03 May 24. 10- and 30-Year comparison reflects Bloomberg Valuation Service (BVAL) AAA Muni Curve and US On-/Off-the-Run Sovereign Curve. AA Muni reflects the Bloomberg AA Muni Bond Index. A Muni reflects the Bloomberg A Muni Bond Index. BBB Muni reflects the Bloomberg BBB Muni Bond Index. HY Muni reflects the Bloomberg High Yield Muni Bond Index. AA Corp reflects the Bloomberg AA Corporate Bond Index. A Corp reflects the Bloomberg A Corporate Bond Index. BBB Corp reflects the Bloomberg BBB Corporate Bond Index. After-tax yield considers top marginal tax rate of 40.8%. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results. Select the image to expand the view.

ENDNOTES

1. Thomson Reuters Municipal Market Data (MMD)

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