Finding Yield Opportunities in Renewed Volatility
June 16, 2022
Read Time 3 MIN
Municipal Market Positive in May
We are experiencing another pronounced sell off in municipal bonds and the market remains far from certain. The May rally in tax-exempt munis may have been over exuberant, as investors were not anticipating the Consumer Price Index (CPI) prints that came in early June. Given Wednesday’s move by the U.S. Federal Reserve (Fed) to hike rates 75 basis points, the largest increase it has made in a single meeting since 1994, yields are on the move to even more attractive levels. Investors may wish to take advantage. Market technicals may also be supportive with the arrival of the summer redemption season. However, there are still many uncertainties on the economic front and ongoing volatility is likely.
Reinvestment Demand Supportive
June and July represent the heaviest period of maturing bonds and coupon payments and these two months normally represent up to 60% of annual redemptions. Typically, municipal issuers come to market during this time, which offsets the demand pressure from reinvestment. Over the past several years, municipalities have been paying down debt and reducing debt issuance, which has created a net negative supply environment. We believe that as long as new issuance remains below long-term averages, municipal bonds will be attractive during June and July.
Credit Quality Remains Strong
Barclay’s reports that the high yield muni default rate remains low and is expected to remain so for the next several months. Moody’s reports that the 10-year average cumulative default rates for investment grate-rated municipals resides at 0.09% while the average 10-year cumulative default rates for high yield stands at 6.94%. Global corporate bonds, however, are a different story. The average 10-Year cumulative default rates for investment grade and high yield, respectively, are 2.17% and 28.92%, for the period documented between 1970 and 2021. Better-than-anticipated revenue collections and the passage of robust stimulus packages have led many analysts to recommend credit risk over interest rate risk so far in the first half of this year. Even through some of the most challenging economic periods, municipals have enjoyed a history of exceptional creditworthiness due to state and local governments’ broad taxing authorities and ability to collect fees for providing essential public services.
|Average 10-Year Cumulative default rates 1970-2021|
Source: Moody's Investors Service . As of April 21, 2022.
While periods of extreme volatility seems to be the new normal, we remain cautiously bullish, as net issuance is expected to turn negative in June, and seasonal reinvestment demand comes into play. We recommend investors consider the Fed’s action at this week’s meeting, and take advantage of the likelihood of lower prices and higher yields to result.
Muni ETFs yields notable across curve and credit
|Taxable Equivalent Per Federal Tax Rate|
|VanEck Muni ETF||Yield to Worst||12%||22%||24%||32%||35%||37%|
|CEF Muni Income (XMPT)||7.0%||7.9%||8.9%||9.2%||10.3%||10.7%||11.1%|
|High Yield Muni (HYD)||5.1%||5.8%||6.5%||6.7%||7.5%||7.8%||8.1%|
|Short High Yield Muni (SHYD)||3.5%||3.9%||4.4%||4.6%||5.1%||5.3%||5.5%|
|Long Muni (MLN)||4.4%||5.0%||5.7%||5.8%||6.5%||6.8%||7.0%|
|Intermediate Muni (ITM)||3.4%||3.8%||4.3%||4.4%||5.0%||5.2%||5.3%|
|Short Muni (SMB)||2.5%||2.8%||3.2%||3.3%||3.6%||3.8%||3.9%|
|Sustainable Muni (SMI)||3.2%||3.7%||4.1%||4.3%||4.8%||5.0%||5.1%|
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