Geopolitical Backdrop And Fed Narrative Open Up Muni Opportunities

Although at this time we are not forecasting negative GDP, we do believe that it is appropriate to pare back our growth expectations for the next 12-24 months. Going forward, we must remain focused on the consumer and future spending patterns and we have to be sufficiently observant to gauge the economic impact of any evolving push-back as accelerating consumer resistance heading into the summer months may ensue. As if inflationary pressure wasn’t already a market headwind, now we have to layer on top potentially wide-ranging price advances throughout multiple industries given that so many products are manufactured with petroleum-based materials. Inflationary pressure is bound to ratchet up and we can expect to see new dimensions with respect to supply chain and pricing dislocations. Most recent bond market activity illustrates the tug-of-war between out-sized inflation coupled with the Fed’s higher interest rate path and a geopolitically driven flight-to-quality bid. While we entered this year expecting lower muni inflow activity, we are obviously seeing the staying power of outflows thanks to the anticipated Fed tightening cycle, weakening performance, and general global uncertainty. Nevertheless, let us not forget the magic of muni technicals, which have the tendency to form the great equalizer for the asset class. Given demonstrated tax-efficiency with reliable tax-exempt cash-flow, above average credit quality and wide-ranging diversification attributes, municipal securities are a proven and necessary investment option for quality-centric portfolios whereby fixed income credit can be ballasted by their relatively low-default experience and higher recovery values.

Although municipal bond fund outflows have totaled just over $12 billion through March 3 according to Refinitiv Lipper data, with noticeable retrenchment in the muni ETF space, we do think that the tide will turn as heavy summer redemptions and bond calls are scheduled to occur, which could be accretive to muni returns. As we have been telegraphing for some time now, munis can act as an inflation hedge given their credit quality characteristics and their demonstrated ability to perform well in a rising rate environment. Cash deployment into the asset class should return and fund flows have a good chance of being net positive at year-end. Let us not overlook some of the compelling market conditions that have emerged this year. Benchmark 10 and 30-year MMD yields have advanced 77 and 73 basis points respectively since the beginning of the year, with the 2s/30s curve flattening by 26 basis points. Relative value ratios are presently at their cheapest levels, 90% and 93% for the 10 and 30-year MMD benchmarks respectively, since October of 2020. All of this volatility has created buying opportunities for the yield-conscious investor, as we question the duration of the currently cheaper levels given prospects for improved market technicals. While we may have further to go to get to “fair value”, we have to understand where munis are today relative to where they were for much of last year and this recognition identifies value. We also think that the fall-off in new issue supply year over year has contained higher yield movements and that the current supply backdrop aligns better with tempered demand for product.

For a comprehensive portfolio evaluation of your municipal holdings, please contact your Oppenheimer Financial Professional.