Weekly Municipal Monitor—Short Munis Shine

Blog

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

Municipals Posted Negative Returns

Municipals posted negative returns last week and underperformed Treasuries across maturities. High-grade municipal yields moved 17-30 bps across the curve. Meanwhile, technicals weakened on heavy fund outflows and higher supply conditions. The Bloomberg Municipal Index returned -0.96% while the HY Muni Index returned -1.50%. This week we highlight the value offered at the short end of the municipal curve.

Technicals Weaken on Elevated Fund Outflows and Higher Supply Conditions

Fund Flows: During the week ending September 28, weekly reporting municipal mutual funds recorded $3.6 billion of net outflows, according to Lipper. Long-term funds recorded $2.4 billion of outflows, high-yield funds recorded $1.0 billion of outflows and intermediate funds recorded $586 million of outflows. The week’s outflows extend year-to-date (YTD) outflows to $92 billion.

Supply: The muni market recorded $7.5 billion of new-issue volume, up about 3x from the prior week. Total YTD issuance of $294 billion is 12% lower than last year’s levels, with tax-exempt issuance trending 3% lower year-over-year (YoY) and taxable issuance trending 45% lower YoY. This week’s new-issue calendar is expected to decline to $4 billion. Larger deals include $1.4 billion New York City General Obligation and $500 million California Earthquake Authority transactions.

This Week in Munis: Short Munis Shine

Fixed-income returns YTD have been challenged by the re-emergence of inflation and the Federal Reserve’s rate-hiking cycle, leaving many investors to re-evaluate downside risks associated with an overall portfolio allocation. Short-duration munis have been one area of the market where risk-adjusted value has emerged amid the volatility. Short-term yields moved to their highest levels in over a decade, taxable-equivalent yields increased at a higher pace than taxable fixed-income and downside risks remain limited by both lower duration and that the Fed’s rate hikes are better reflected in short maturities.

Explore 1-Year AAA Municipal Yield and Taxable-Equivalent Yield

Short-term municipal bond yields moved to their highest levels since 2007. Following the Fed increasing short-term rates at all six Federal Open Market Committee (FOMC) meetings this year, the 1-year AAA municipal bond yield, which fell as low as 0.05% in 2021, increased 290 bps YTD to 3.0% last week. Notably, the impact of Fed rate increases has been particularly pronounced at the short end of the municipal curve, as intermediate to long maturities increased just 220-240 bps despite their longer duration. As such, short-duration munis now offer more attractive yields per unit of duration risk.

Explore Municipal vs. Treasury Yield Increases YTD

The increasing value of tax-exempt income at higher nominal rates contributes to a favorable after-tax relative value proposition. At the end of 2021, an individual in the top marginal tax bracket would record a higher after-tax yield in a 1-year Treasury than in a 1-year AAA municipal security. Despite the 1-year tax-exempt yield increasing at a lower nominal rate than the 1-year Treasury (+356 bps) YTD, the increased value of the tax exemption at higher nominal rates has translated to a better after-tax yield pickup for the AAA muni versus the comparable Treasury counterpart. Last week the spread between the 1-year Muni yield-to-worst (YTW) (3.04%) and the 1-year after-tax Treasury YTW (2.35%) reached 69 bps, well above the historical average of 15 bps.

Explore muni-monitor-20221004-exhibit-3-web.png

While 2022 has been a challenging year for fixed-income investors, a silver lining to the market volatility has been that savers and income seekers can now enjoy relatively high income levels at the short end of the curve. After years of short-term municipals bonds offering yields of 30 bps or less, the tightening program by the Fed has now created trading opportunities in the 1- to 5-year area of the municipal market, including credit spread opportunities that an active manager can exploit. Western Asset believes investors looking for a defensive area of the fixed-income market should consider adding exposure to short-duration munis considering the relatively high absolute yield levels, relative after-tax yield levels versus taxable asset classes, along with the structural downside protection offered by relatively lower duration and Fed rate hike activity better priced within the short end of the curve.

Explore Municipal Bond Yields and Index Returns

Explore Tax-Exempt and Taxable Muni Valuations

© Western Asset Management Company, LLC 2024. 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 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 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.