Early 2014 Municipal Bond Market Stabilization & Rally

Since the end of last year, the 10-year Treasury has worked its way to 2.66%, down from 3.02% on December 31st. A combination of emerging market unrest – both financial and political – and the seemingly perpetual polar vortex has caused the economy to slow, sending bond yields lower and prices higher. Municipal bonds have rallied concurrently with Treasuries, but to a slightly greater extent. The 10-year muni/Treasury ratio has decreased from 101.1% in early January to 94.51% on February 27th1. This means the average municipal 10-year rate is equivalent to 94.51% of the 10-year Treasury rate.

Prices benefit from lower supply & stabilizing market

Municipal bond prices have benefitted from a relatively lower supply of new issuance volume, paired with the market stabilizing after the negative initial reaction to Detroit and Puerto Rico’s financial woes. Low issuance is largely driven by the rising yield curve, meaning many refinancing opportunities are not currently feasible. Additionally, as higher tax rates set in, investor demand for non-taxable income is on the rise. 

Fund flow reversal signals retail reengagement

Recent mutual fund flows indicate a gradual reengagement of retail investors to the asset class. According to the ICI Institute, we have experienced six straight weeks of municipal bond inflows totaling $1.6 billion. This is paltry in comparison to the previous 33 straight weeks of outflows totaling $65.3 billion, but is certainly a positive trend. 

Tapering expected to continue

Assuming U.S. growth continues at its recent pace, we expect new Fed Chair Janet Yellen to continue current Fed policies of tapering. The market is not anticipating the first rate hike until 2015 given tame inflation readings well below the 2% target and employment figures, which still demonstrate an economy functioning at under-capacity levels.

As always, please call us if you have any questions or would like a portfolio review.

Matthew Bernardi
Bernardi Securities, Inc.
February 28, 2014

(1) Source: Bloomberg