Weekly Municipal Monitor—Mid-Year Report

Blog

Stay up to date on timely topics and market events. Subscribe to our Blog now.

Municipals Posted Positive Returns Last Week

AAA municipal yields moved 5 bps lower in intermediate and long maturities, trailing Treasuries lower. US municipals underperformed Treasuries as Municipal/Treasury ratios moved 1% to 4% higher during the week. The Bloomberg Barclays Municipal Index returned 0.21%, while the HY Muni Index returned 0.41%. Municipal mutual fund flows maintained a record pace as supply declined. Now that we’re halfway through 2021, this week we discuss year-to-date (YTD) performance, technicals and fundamentals in the muni market.

This Week in Munis: Mid-Year Report

Performance
Through the first half of 2021, municipals posted positive performance, shrugging off the negative returns observed in other fixed-income asset classes. The Bloomberg Barclays Municipal Bond Index returned 1.06% and the Bloomberg Barclays Taxable Muni Index returned 0.30% YTD, outperforming the U.S. Aggregate (-1.60%), the U.S. Corporate Index (-1.27%) and the U.S. Treasury Index (-2.58%).

Curve Returns: Longer-term municipals outperformed through the first half of the year, with the 15-year, 20-year and 22+ year indices returning 1.24%, 1.79% and 2.33%, respectively. The 5-year and 7-year indices underperformed, posting returns of 0.17% and 0.18%, respectively.
Sector Returns: From a sector perspective, reopening sectors outperformed, with health care and transportation returning 2.15% and 1.93%, respectively. Higher quality water & sewer and electric utility sectors lagged the market, returning 0.34% and 0.47%, respectively.
Quality Returns: Reversing trends from 1H20, lower-quality municipals were the best performers, with High Yield, BBB and A indices returning 6.13%, 3.91% and 1.75%, respectively. AAA and AA municipal indices underperformed, returning 0.06% and 0.51%, respectively.

Technicals Driving Outperformance

Higher, Yet Limited Tax-Exempt Supply: Total tax-exempt issuance of $170 billion is trending 21% higher year-over-year (YoY), but is still tracking 18% below the levels observed in 2017 when the Tax Cuts and Jobs Act eliminated tax-exempt advanced refunding.
Record Tax-Exempt Municipal Demand: Municipal outperformance is largely related to the unrelenting demand for tax-exempt income. Municipal mutual funds recorded inflows at a record pace YTD, at $59.5 billion. Long-term funds recorded $37 billion, high-yield funds recorded $14 billion, and intermediate funds recorded $11 billion of net new capital. Municipal funds observed inflows in 58 of the past 59 weeks, totaling $121 billion. In addition to municipal fund demand, increasing demand from institutional investors, SMA investors and seasonally high coupon reinvestment are supporting a strong bid for the asset class.
Elevated Taxable Municipal Supply: Taxable municipal supply, including corporate issuance, declined 10% YoY to $66 billion. While rate volatility contributed to modest issuance declines, taxable issuance is still well above longer-term averages at 28% of total municipal issuance as issuers refund outstanding tax-exempt debt through taxable issuance.
Increasing Taxable Municipal Demand: As taxable issuance has increased, so has the taxable municipal buyer base. According to the Federal Reserve’s flow-of-funds data through 1Q21, primary holders of taxable municipal issuance increased their municipal holdings approximately 7% from 1Q20. Banks increased their holdings 7% to $528 billion, P&C insurance companies increased holdings 5% to $294 billion, life insurers increased muni allocations 8% to $231 billion, non-US investors increased holdings 1% to $104 billion.

Credit Fundamentals and Outlook Improve

Municipal fundamentals continue to improve as economies reopen and ongoing Covid vaccinations progress. According to the Census, major state and local revenues (property, income and sales taxes) were 10% higher in 1Q21 versus 1Q20. Better than expected revenues, combined with direct federal aid measures that will continue to be rolled out, will bolster municipal credit.

The credit improvement is evident in some of the market’s most challenged credits. Just last week, the state of Illinois was upgraded by Moody’s, from Baa3 to Baa2. The upgrade was a stark contrast to the pre-pandemic debate on whether the sixth most populous state would be downgraded to high-yield status.

With valuations retraced fully past pre-pandemic levels, finding relative value in the market is increasingly difficult, and we believe independent credit surveillance is increasingly important. We continue to favor those issuers and sectors that would benefit from a recovery, particularly among transportation, health care and select high-yield issuers. Meanwhile, we believe the market is providing an opportunity to improve portfolio liquidity, providing flexibility in the event of unforeseen market volatility.

Explore Municipal Bond Yields and Index Return

© Western Asset Management Company, LLC 2025. The information contained in these materials ("the materials") is intended for the exclusive use of the designated recipient ("the recipient"). This information is proprietary and confidential and may contain commercially sensitive information, and may not be copied, reproduced or republished, in whole or in part, without the prior written consent of Western Asset Management Company ("Western Asset").

Past performance does not predict future returns. These materials should not be deemed to be a prediction or projection of future performance. These materials are intended for investment professionals including professional clients, eligible counterparties, and qualified investors only.

These materials have been produced for illustrative and informational purposes only. These materials contain Western Asset's opinions and beliefs as of the date designated on the materials; these views are subject to change and may not reflect real-time market developments and investment views.

Third party data may be used throughout the materials, and this data is believed to be accurate to the best of Western Asset's knowledge at the time of publication, but cannot be guaranteed. These materials may also contain strategy or product awards or rankings from independent third parties or industry publications which are based on unbiased quantitative and/or qualitative information determined independently by each third party or publication. In some cases, Western Asset may subscribe to these third party's standard industry services or publications. These standard subscriptions and services are available to all asset managers and do not influence rankings or awards in any way.

Investment strategies or products discussed herein may involve a high degree of risk, including the loss of some or all capital. Investments in any products or strategies described in these materials may be volatile, and investors should have the financial ability and willingness to accept such risks.

Unless otherwise noted, investment performance contained in these materials is reflective of a strategy composite. All other strategy data and information included in these materials reflects a representative portfolio which is an account in the composite that Western Asset believes most closely reflects the current portfolio management style of the strategy. Performance is not a consideration in the selection of the representative portfolio. The characteristics of the representative portfolio shown may differ from other accounts in the composite. Information regarding the representative portfolio and the other accounts in the composite are available upon request. Statements in these materials should not be considered investment advice. References, either general or specific, to securities and/or issuers in the materials are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendation to purchase or sell such securities. Employees and/or clients of Western Asset may have a position in the securities or issuers mentioned.

These materials are not intended to provide, and should not be relied on for, accounting, legal, tax, investment or other advice. The recipient should consult its own counsel, accountant, investment, tax, and any other advisers for this advice, including economic risks and merits, related to making an investment with Western Asset. The recipient is responsible for observing the applicable laws and regulations of their country of residence.

Founded in 1971, Western Asset Management Company is a global fixed-income investment manager with offices in Pasadena, New York, London, Singapore, Tokyo, Melbourne, São Paulo, Hong Kong, and Zürich. Western Asset is a wholly owned subsidiary of Franklin Resources, Inc. but operates autonomously. Western Asset is comprised of six legal entities across the globe, each with distinct regional registrations: Western Asset Management Company, LLC, a registered Investment Adviser with the Securities and Exchange Commission; Western Asset Management Company Ltda. is regulated by Comissão de Valores Mobiliários; Western Asset Management Company Pty Ltd ABN 41 117 767 923 is the holder of the Australian Financial Services License 303160; Western Asset Management Company Pte. Ltd. Co. Reg. No. 200007692R is a holder of a Capital Markets Services License for fund management and regulated by the Monetary Authority of Singapore; Western Asset Management Company Ltd, a registered Financial Instruments Business Operator and regulated by the Financial Services Agency of Japan; and Western Asset Management Company Limited is authorised and regulated by the Financial Conduct Authority ("FCA") (FRN 145930). This communication is intended for distribution to Professional Clients only if deemed to be a financial promotion in the UK as defined by the FCA. This communication may also be intended for certain EEA countries where Western Asset has been granted permission to do so. For the current list of the approved EEA countries please contact Western Asset at +44 (0)20 7422 3000.