Municipal Bond Performance on Track for Worst May Since 1986

(Bloomberg) - This month is on track to be the worst May in recent history for municipal bonds amid the elevated interest-rate environment and Treasury volatility caused by fear of a US default.

Municipal bonds lost 1.38% so far in May, according to data compiled by Bloomberg. Barring a major rally, that puts this month on track for the worst May performance since 1986, when bonds lost 1.63%. On average, munis gained 0.9% in May over the last decade, the strongest month of returns, buoyed by expectations of summer rallies.

Investors say the unusual weakness reflects a range of factors — chief among them an uptick of issuance after weeks of low supply that kept demand high, as well as renewed fears of additional rate hikes that dampened the performance of all types of fixed income. And even more alarming are concerns over US default as investors in state and local government debt tend to be risk averse. Fitch Ratings warned Wednesday that the US’s AAA rating is under threat as the White House and Congressional Republicans try to reach an agreement.

“What you are seeing in May is a temporary dynamic,” RJ Gallo, senior vice president at Federated Hermes, said.

Read more from Bloomberg Intelligence: Rate Spike, Cheaper Ratios Aren’t Turning Muni Heads Just Yet

Federal Reserve officials at their May meeting were divided over whether further rate increases would be necessary to lower inflation amid uncertainty about the impact of banking-sector stresses on the economy. Fears of further rate hikes, along with anxiety over the debt ceiling, fueled weakness in Treasuries, with a benchmark index of federal government securities losing 2.17% month to date. Munis tend to move in sympathy with Treasuries.

Earlier this month, BlackRock Inc. and the Federal Deposit Insurance Corp. started unwinding the balance sheet of Silicon Valley Bank, which held roughly $7 billion of municipal bonds in its portfolio. That increased selling has pushed up supply in the secondary market and put pressure on prices, Matt Buscone, co-head of portfolio management at Breckinridge Capital Advisors. said.

The portfolio sale “impacted the market more than people thought,” he said. Most of the bonds were longer-dated debt with low coupons, which are less attractive in a rising rate environment.

Insurers, mutual funds and big banks are the most likely buyers of the bonds being unloaded by BlackRock, and as a result some sold similarly structured securities to prevent overexposure, further boosting supply of munis in the market, Buscone said.

Despite the lackluster month, Gallo said he remains optimistic because summer is just around the corner, a historically strong season for munis because supply tends to wane. Buscone agrees, “we usually highlight June, July and August as the strongest months.”

Gallo believes inflation has peaked and the Fed is closer to being done with its rate-hiking cycle. “Those are pretty tall tailwinds for fixed-income investors,” he said.

By Nic Querolo


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