The municipal bond market has shown resilience and stability in the days leading up to the Thanksgiving holiday, thanks to a series of strong technical factors that have allowed these securities to outperform their U.S. Treasury and corporate counterparts. This article will delve into the current state of the municipal market, the implications of supply dynamics, and the broader economic forecast impacting future municipal performance.
As the trading week dwindles ahead of Thanksgiving, the municipal bond market appears to be in a state of minimal change, reflecting a period of consolidation. Notably, yields for triple-A municipal bonds have remained relatively stagnant, remaining steady for the past nine trading sessions. Meanwhile, U.S. Treasuries have experienced slight fluctuations, with short-term securities seeing losses while longer maturity securities enjoyed modest gains.
Peter DeGroot, a prominent figure at J.P. Morgan, emphasized that the reprieve observed in November has ushered in substantial outperformance across the entire municipal yield curve. This trend can be attributed to a combination of technical factors aligning favorably, including a notable decrease in supply that has allowed market participants to regroup, bolstering their positions in this segment of the bond market.
An important factor contributing to the current stability in the municipal bond market is the significant reduction in supply, which has led to a decline in dealer inventories. Mikhail Foux from Barclays pointed out that while market participants had initially feared the implications of volatility in interest rates and potential taxation changes, this has not deterred retail investors. They continue to actively seek out tax-exempt securities, reflecting confidence in the municipal market even amidst uncertain conditions.
The data reflects a balanced approach, with tax-exempt ratios remaining relatively neutral compared to corporates. Current readings from Refinitiv Municipal Market Data and ICE Data Services suggest that the two-year municipal to UST ratio stands at 60%, while the 30-year is at 82%. Despite some analysts expressing caution regarding valuation attractiveness, it appears that the buying interest from retail investors remains strong.
As we enter a shortened trading week, the projected calendar for new municipal issues amounts to just over $1.4 billion. This figure will play a crucial role in determining how the market behaves moving into December. According to Bond Buyer, there is ongoing visibility of $6.91 billion in supply, but as figures indicate a substantial net negative supply for December, this could maintain the supportive technical backdrop necessary for continued municipal outperformance.
In the historical context, December is traditionally a strong month for municipal bonds, particularly high-grade issues, which have consistently posted positive returns over the last decade. Foux suggests that while high yields may be more erratic month-over-month, the average returns still reflect optimism. Investors will meticulously observe upcoming macroeconomic data, including the third-quarter core Personal Consumption Expenditures (PCE), which is anticipated to provide insights relevant to the Federal Open Market Committee (FOMC) meetings.
Despite some uncertainty in the rate adjustment outlook, current economic indicators suggest that the U.S. economy has performed adequately in the third quarter. Foux notes an upward trend in the economic surprise index, presenting a more positive economic outlook. Forecasts for the upcoming third-quarter GDP growth hover around 2.8%, reinforcing the notion that a major downturn is unlikely in the near future.
With December fast approaching, there are expectations of potential market richness, especially in the latter part of the month. While there remain apprehensions regarding the trading environment and future valuations, it is crucial to recognize the historical propensity for municipal bond performance to shine during this time. DeGroot reiterates the attractive absolute yields available in the context of recent trends, which may encourage enhanced performance in the months to follow, assuming stability persists in the rates market.
Overall, the municipal bond market is navigating through a complex environment marked by supply-demand dynamics, investor sentiment, and broader economic indicators. With the strong performance metrics of November and promising historical patterns, the outlook remains cautiously optimistic. Municipal bonds are likely well-positioned to continue their strong track record as we approach December, suggesting that now could be an opportune time for savvy investors to reassess their portfolios in light of changing market conditions.