Wednesday, March 29, 2023
After one of the weakest February’s on record, the municipal market is on track for its strongest March performance since 2008, as it benefits from a flight to safety amid turmoil in the banking industry. The Bloomberg Municipal Index is up nearly 2% (so far) this month bucking the historical trend of March being the worst month for muni investors. Since 2011, the Bloomberg Municipal Index has lost -0.39%, on average, in March, making it the worst month for the index. The good news for muni investors? The next two months have been good months for muni investors with April and May generating, on average, monthly returns of 0.25% and 0.97%, respectively.
That said, the ongoing banking sector stress could bleed into the municipal market. U.S. depository institutions hold $580 billion of municipal debt—14% of total municipal debt outstanding—according to Federal Reserve (Fed) Flow of Funds data as of year-end 2022. Moreover, according to FDIC Q4 2022 call report data, approximately 57% of bank muni holdings were available for sale. So, there remains a chance that banks could sell municipal holdings and use the cash to shore up balance sheets and/or potentially raise liquidity to meet customers’ withdrawal demands. With the Fed’s new lending facility though (which we wrote about here), the need to quickly sell securities in times of stress has been reduced, in our view.
A further wildcard remains how investors will react going forward. While flows into muni mutual funds have generally been positive this year, the last six weeks have seen outflows (according to the Investment Company Institute). If demand stabilizes, along with what is expected to be a light month (April) of new issuance, the supply/demand picture could be a favorable one for munis over the next few months. Nonetheless, with starting index yields still above longer term averages, and with the fundamental story still a positive one, we would see any municipal sell off as a potential buying opportunity.
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