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Municipal Bonds: Muni Volatility Overshadows Strong Sector Fundamentals

Munis represent an opportunity for tax-averse investors to generate long-term income streams.

August 02, 2022


This Municipal sector report is excerpted from the Third Quarter 2022 Fixed-Income Sector Views.

Technical factors continued to dominate the municipal market through the second quarter, during which tax-exempt munis declined by 2.9 percent, taking year-to-date returns as of June 30 to -8.98 percent. Taxable munis returned -6.2 percent in the second quarter and -14.0 percent year to date.

Tax exempt munis faced a buyers’ strike for most of 2022, as fears over inflation prompted mutual fund outflows totaling $77 billion—on pace to exceed previous totals for full year 2021. Despite a manageable new issue supply of $166 billion as of June 30, 2022, just 3 percent less than the same period last year, funds have had to sell positions to meet redemptions. Consequently, the market’s less-liquid segments, including sub-5 percent coupon bonds and high-yield, have materially underperformed other sectors. A brief respite came in late May, when municipal/Treasury yield ratios reached 12-month highs and a couple of large deals cleared the market at attractive spreads, drawing in crossover buyers. However, the selloff resumed as rate volatility returned, with tax exempts down 1.8 percent in June.

Taxable municipals suffered worse returns than tax exempts this year due to their longer duration, and their spreads widened in conjunction with other credit sectors. As of June 30, index-eligible taxables still trade tighter than corporates, as year-to-date issuance volumes dropped 45 percent versus 2021.

Performance aside, municipal credit quality remains strong. Upgrades consistently outnumber downgrades, and defaults are low. At the state level, rainy day funds are expected to remain high for fiscal year 2023 despite lackluster revenue expectations, as states draw down funds from the American Rescue Plan.

In our view, tax-exempt investors should focus on liquid structures, such as callable 5 percent coupon bonds, ideally with a non-call period beyond five years to minimize the negative convexity profile. Tax averse, income-oriented investors should consider allocations at current market levels, despite municipal/Treasury ratios having recovered from their one year wides. While 10-year ratios hover around 91 percent, the 2.7 percent yield on 10-year AAA munis is in line with late March 2020, when ratios hit a record high of 370 percent. Municipal credits are bespoke and trade mostly by appointment, so we believe investors should view the sector as an opportunity to lock in satisfactory income over time rather than waiting for short-lived turning points like late May 2022.

10-Year AAA Muni Yields Mirror March 2020, When Muni/Treasury Ratios Peaked

10-Year AAA Muni Yields Mirror March 2020, When Muni/Treasury Ratios Peaked

Source: Guggenheim Investments, The Municipal Market Monitor (TM3). Data as of 6.30.2022.

—By Allen Li and Michael Park

 
Important Notices and Disclosures

This material is distributed or presented for informational or educational purposes only and should not be considered a recommendation of any particular security, strategy or investment product, or as investing advice of any kind. This material is not provided in a fiduciary capacity, may not be relied upon for or in connection with the making of investment decisions, and does not constitute a solicitation of an offer to buy or sell securities. The content contained herein is not intended to be and should not be construed as legal or tax advice and/or a legal opinion. Always consult a financial, tax and/or legal professional regarding your specific situation.

This material contains opinions of the authors, but not necessarily those of Guggenheim Partners, LLC or its subsidiaries. The opinions contained herein are subject to change without notice. Forward-looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable but are not assured as to accuracy. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information.

Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-backed securities, may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity risk. Investments in floating rate senior secured syndicated bank loans and other floating rate securities involve special types of risks, including credit risk, interest rate risk, liquidity risk and prepayment risk.

Guggenheim Investments represents the following affiliated investment management businesses: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Partners Advisors, LLC, Guggenheim Corporate Funding, LLC, Guggenheim Partners Europe Limited, Guggenheim Partners Fund Management (Europe) Limited, Guggenheim Partners Japan Limited, GS GAMMA Advisors, LLC, and Guggenheim Partners India Management.

©2022, Guggenheim Partners, LLC. All Rights Reserved. No part of this document may be reproduced, stored, or transmitted by any means without the express written consent of Guggenheim Partners, LLC.

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FEATURED PERSPECTIVES

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© Guggenheim Investments. All rights reserved.

Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Partners Advisors, LLC, Guggenheim Corporate Funding, LLC, Guggenheim Partners Europe Limited, Guggenheim Partners Japan Limited, GS GAMMA Advisors, LLC, and Guggenheim Partners India Management.