Quick takes on capital markets

10 Jun 2022

Municipal bonds: "Summer buying season"

A rough start to the year sent municipal bond yields rising nearly 250bps by mid-May, yet the asset class is beginning to show new signs of life. Muni yields should start peaking as we enter summer buying season, when demand often outpaces supply, while an eventual leveling in 10-year U.S. Treasury yields as recession fears grow should soon provide support for investors.

Municipal bond yields
Bloomberg Municipal Bond Index, yield to worst, January 1, 2022 – present

Municipal bond yield chart
Source: Barclays Point, CreditSights, Principal Global Investors. Data as of June 6, 2022.

Municipal bonds had a rough start to 2022. Demand dwindled significantly as investors retreated to safer havens amid rising interest rates—yields soared nearly 250 basis points, to 3.5%, by mid-May. More recently however, yields had shown tentative signs of peaking, enabling a stronger performance for munis. As the asset class enters the "summer buying season" investors may soon see a turning of the tide.

  • Demand for municipal bonds typically increases in the summer. The principal and interest payments returned to investors during June, July and August are traditionally the highest of the year and usually exceed supply. This year is no exception—the proceeds of principal and interest payments could be up to 60% higher in the "summer buying season" than during other months.
  • The 10-year U.S. Treasury yield should start to level off as concerns over slower growth increase. This will likely lead to stability in the NAV of municipal bond funds, which should slow the outflow cycle that was driving up yields.

Although rising policy rates and slowing growth will continue to disrupt and unsettle broader markets in the medium-term, a potential reversal of fortunes in both municipal bond yields and demand, combined with already-strong credit fundamentals, suggests now might be an attractive entry point into the asset class.

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