Municipal bond yields have moved considerably higher this year in response to increasing U.S. Treasury yields and muni mutual fund outflows. Markets are repricing a more aggressive tightening cycle for 2022 as the Federal Reserve tries to bring down stubbornly high inflation.
Muni bond funds, after record inflows of $101 billion in 2021, experienced outflows for 15 consecutive weeks in 2022.* The result? The first quarter total return of the Bloomberg Municipal Bond Index (-6.23%) marked the worst quarter since Q3 1981 (-9.69%). It was also the worst return for a first quarter since 1980.
Bloomberg Muni Index quarterly return analysis (1990–2022)
Source: Bloomberg Municipal Bond Index.
Typically, such a market return could be a negative omen for future muni fund flows. And maybe it will be. Muni fund outflows pressure returns as managers sell bonds to raise cash for redemptions. Muni bond funds have been in outflows in early 2022 as $38 billion has been redeemed as of April 21, 2022 (JPMorgan).
However, we may see brighter days ahead
1. Our analysis (above) shows that historically, muni index returns are positive in the 3 quarters after a difficult return quarter.
2. Muni index returns usually turn positive 2-3 months before muni fund outflows end (see table below)
Source: Lipper U.S. Fund Flows 2021, JPMorgan.
3. Overall, muni sector credit fundamentals remain strong, we believe
4. Muni taxable equivalent yields are attractive at 5%+ (see below)
5. State and local pension funding is at its highest level since 2008
6. Muni defaults remain within long-term ranges and are isolated in the lowest rated/nonrated cohorts
7. Higher interest rates could dampen refunding/refinancing activity, reducing new issue supply estimates
8. U.S. equity markets remain near all-time highs as of this writing
Muni taxable equivalent yields (TEY) are attractive at nearly 5%
Sources: Bloomberg Municipal Bond yield data, with Putnam analysis of impact of 40.8% tax rate. The 40.8% tax rate comprises 37% (highest marginal U.S. income tax rate) + 3.8% NIIT rate.
We believe investors may want to consider an allocation to the municipal bond asset class.
Learn more about our active, research-driven approach to tax-exempt investing.
Evaluate yields on a tax-equivalent basis
Compare municipal funds on equal footing with taxable bond funds.
The Bloomberg Municipal Bond Index is an unmanaged index of long-term fixed-rate investment-grade tax-exempt bonds. You cannot invest directly in an index.
BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). Bloomberg or Bloomberg’s licensors own all proprietary rights in the Bloomberg Indices. Neither Bloomberg nor Bloomberg’s licensors approve or endorse this material, or guarantee the accuracy or completeness of any information herein, or make any warranty, express or implied, as to the results to be obtained therefrom, and to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.
For informational purposes only. Not an investment recommendation.
This material is provided for limited purposes. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, or any Putnam product or strategy. References to specific asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations or investment advice. The opinions expressed in this article represent the current, good-faith views of the author(s) at the time of publication. The views are provided for informational purposes only and are subject to change. This material does not take into account any investor’s particular investment objectives, strategies, tax status, or investment horizon. Investors should consult a financial advisor for advice suited to their individual financial needs. Putnam Investments cannot guarantee the accuracy or completeness of any statements or data contained in the article. Predictions, opinions, and other information contained in this article are subject to change. Any forward-looking statements speak only as of the date they are made, and Putnam assumes no duty to update them. Forward-looking statements are subject to numerous assumptions, risks, and uncertainties. Actual results could differ materially from those anticipated. Past performance is not a guarantee of future results. As with any investment, there is a potential for profit as well as the possibility of loss.
Diversification does not guarantee a profit or ensure against loss. It is possible to lose money in a diversified portfolio.
Consider these risks before investing: International investing involves certain risks, such as currency fluctuations, economic instability, and political developments. Investments in small and/or midsize companies increase the risk of greater price fluctuations. Bond investments are subject to interest-rate risk, which means the prices of the fund’s bond investments are likely to fall if interest rates rise. Bond investments also are subject to credit risk, which is the risk that the issuer of the bond may default on payment of interest or principal. Interest-rate risk is generally greater for longer-term bonds, and credit risk is generally greater for below-investment-grade bonds, which may be considered speculative. Unlike bonds, funds that invest in bonds have ongoing fees and expenses. Lower-rated bonds may offer higher yields in return for more risk. Funds that invest in government securities are not guaranteed. Mortgage-backed securities are subject to prepayment risk. Commodities involve the risks of changes in market, political, regulatory, and natural conditions. You can lose money by investing in a mutual fund.
Putnam Retail Management.