After a brutal 2022, the municipal bond market began this year on a positive note, with a light new issue calendar, plenty of investor demand for bonds with respectable yields, and a collective assumption that inflation was tapering off and Federal Reserve rate hikes were winding down. The S&P Municipal Bond Index was up 2.82% in January, the second-best January performance in 30 years.
The January 2023 muni market felt like a rose garden.
Primary market supply in January was well below the average of the prior five years as proceeds from coupon income, called bonds, and maturing issues sought reinvestment. Municipal bond mutual funds finally experienced inflows after a year of record-breaking redemptions in 2022. Technicals were positive and it was beginning to feel like the municipal market had turned the corner and that the best yield opportunities were behind us.
These dynamics reversed rapidly in February as various data has indicated stickier inflation and the Fed reiterated a determined hawkish position with continued interest rate hikes. Amid changing investor sentiment, January fund inflows reversed in February, according to Refinitiv Lipper. Strong January returns disappeared with February’s selloff.
Yields Moved Higher In February
Bloomberg US General Obligation AA Muni Yield Curve change 2/2/23 vs. 2/24/23
Seasonal challenges and fixed income market volatility could create opportunity
Looking ahead, the muni market is on the cusp of seasonal challenges, including a heavier new issue calendar, diminished level of reinvestment proceeds from maturing and called bonds, and municipal bond mutual fund redemptions as investors raise cash for April tax payments. When overlaid with general fixed income market volatility, the possibility of disorder and the subsequent opportunities it could create in the near term bodes well for those considering initial muni investments or adding to existing portfolios.
Municipal credit quality remains stellar in terms of sales, income and property tax revenues, replenished rainy day funds, and disciplined spending for most state and local governments.
At Riverbend, we continue to favor essential service revenue bonds (water, sewer, utilities), general obligations of well-managed state and local governments, healthcare bonds of large, diversified hospital systems, and higher ed bonds for colleges and universities with strong enrollment trends and larger endowments. We recommend avoiding the debt of senior living facilities, nursing homes, convention centers, small private colleges, and project specific issuers.
Stick with quality. Stay involved. The door seems to have reopened.