skip navigation
Blog

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

MARKETS
January 24, 2023

Weekly Municipal Monitor—Inflows Ahead?

By Sam Weitzman

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

Municipals Posted a Third Consecutive Week of Positive Returns

Municipals posted positive returns for a third consecutive week, as high-grade municipal yields moved 6-12 bps lower. Strong technicals led municipals to outperform Treasuries, which moved lower on weaker than expected US retail sales and Producer Price Index (PPI) data releases. The Bloomberg Municipal Index returned +0.51%, the HY Muni Index returned +0.57% and the Taxable Muni Index returned +0.28%. Following a second consecutive week of muni fund inflows, we evaluate the scope of the 2022 record outflow cycle and the factors that could shift demand into the asset class in 2023.

Municipal Mutual Funds Post a Second Consecutive Week of Inflows

Fund Flows: During the week ending January 18, Lipper weekly reporting municipal mutual funds recorded $1.5 billion of net inflows. Long-term funds recorded $1.5 billion of inflows, high-yield funds recorded $823 million of inflows and intermediate funds recorded $185 million of inflows. The week’s inflows reduce year-to-date (YTD) outflows to $3.3 billion.

Supply: The muni market recorded $10 billion of new-issue volume last week, more than doubling the prior week’s level. YTD issuance stands at $16 billion, 91% of which was tax-exempt. This week’s calendar is expected to decline to $6 billion. Large transactions include $2.1 billion University of California and $950 million Port of Portland, Oregon transactions.

This Week in Munis: Inflows Ahead?

In recent weeks we highlighted an expectation of rebounding municipal technicals in 2023, largely driven by demand returning to the muni asset class following a record open-end fund outflow cycle that reached $151 billion over 51 weeks, according to ICI. The 2022 muni fund flow drawdown was also more acute than the drawdowns observed from taxable fixed-income sectors. Morningstar estimates that 2022 municipal fund outflows comprised 11% of starting assets under management (AUM), compared to just 4% flow drawdowns from taxable fixed-income.

Exhibit 1: Primary Municipal Outflow Cycles Since 2008
Explore Primary Municipal Outflow Cycles Since 2008
Source: Bloomberg, ICI. As of 04 Jan 23. Select the image to expand the view.

Historically, positive muni demand cycles and favorable performance have followed sizable outflow cycles. Assessing what could drive the next inflow cycle, we point to the factors that we believe were primary drivers of the 2022 negative demand cycle, including: (1) relatively tight municipal valuations at the start of the year, (2) upside inflation surprises that contributed to interest-rate volatility and (3) end-of-year tax-loss selling. Entering 2023, we see signs of optimism across these factors. Higher rates have improved municipal relative value, inflation has shown signs of abating and tax-loss selling has decelerated. Moreover, during prior outflow cycles, municipal market prices typically recovered less than halfway through the period, with the second half of outflow cycles typically experiencing positive returns. We anticipate that the market price recovery observed in the last quarter could serve as a signal of stability and attract demand back to the municipal market this year.

Exhibit 2: Outflows and Subsequent Inflows
Explore Outflows and Subsequent Inflows
Source: Bloomberg, ICI. Starting yield as of 04 Jan 23. Select the image to expand the view.
Outflow periods defined as follows:
2008: 17 Sep 08–31 Dec 08; 2010–2011: 03 Nov10–04 May 11; 2013: 06 Mar 13–08 Jan 14; 2016: 26 Oct 16–04 Jan 17; 2018: 19 Sep 18–19 Dec 18; 2020: 26 Feb 20–08 Apr 20; 2022 12 Jan–30 Sep 22
Note: 2022 period reflects current outflow cycle which is still in progress, starting yield as of 04 Jan 23.

The past two weeks may prologue the start of the next inflow cycle, and we expect most municipal investors would be eager to experience performance comparable to prior positive demand cycles. The Bloomberg Muni Bond Index returned 13.4%, on average, during the prior six inflow cycles. While we believe that the strong performance observed so far this year should warrant caution and could contribute to potential near-term price volatility, we anticipate that supportive supply and demand technicals could lead to challenging entry points for traditional muni investors throughout the year. An active manager can help investors navigate relative value during these periods.

Exhibit 3: Municipal Bond Yields and Index Returns
Explore Municipal Bond Yields and Index Returns
Source: Bloomberg. As of 20 Jan 23. Select the image to expand the view.
Exhibit 4: Tax-Exempt and Taxable Muni Valuations
Explore Tax-Exempt and Taxable Muni Valuations
Source: Bloomberg. As of 20 Jan 23. Select the image to expand the view.
© Western Asset Management Company, LLC 2023. This publication is the property of Western Asset and is intended for the sole use of its clients, consultants, and other intended recipients. It should not be forwarded to any other person. Contents herein should be treated as confidential and proprietary information. This material may not be reproduced or used in any form or medium without express written permission.
Past results are not indicative of future investment results. This publication is for informational purposes only and reflects the current opinions of Western Asset. Information contained herein is believed to be accurate, but cannot be guaranteed. Opinions represented are not intended as an offer or solicitation with respect to the purchase or sale of any security and are subject to change without notice. Statements in this material should not be considered investment advice. Employees and/or clients of Western Asset may have a position in the securities mentioned. This publication has been prepared without taking into account your objectives, financial situation or needs. Before acting on this information, you should consider its appropriateness having regard to your objectives, financial situation or needs. It is your responsibility to be aware of and observe the applicable laws and regulations of your country of residence.
Western Asset Management Company Distribuidora de Títulos e Valores Mobiliários Limitada is authorized and regulated by Comissão de Valores Mobiliários and Brazilian Central Bank. Western Asset Management Company Pty Ltd ABN 41 117 767 923 is the holder of the Australian Financial Services Licence 303160. Western Asset Management Company Pte. Ltd. Co. Reg. No. 200007692R is a holder of a Capital Markets Services Licence for fund management and regulated by the Monetary Authority of Singapore. Western Asset Management Company Ltd is a registered Financial Instruments Business Operator and regulated by the Financial Services Agency of Japan. 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.