Despite continual mutual fund outflows, the municipal market has kept pace with a significant rally in the Treasury market over the course of the last two months. Broadly speaking, municipal bonds are still inexpensive compared to Treasuries as the muni/Treasury ratio – the municipal rate divided by the corresponding Treasury rate – stands at 108%. Overhang of headline risk stemming from financial meltdowns in Detroit, Puerto Rico and places yet to be named will likely cause this high ratio to persist for some time. This dynamic presents an opportunity for fixed income investors.
Bond price rally defies 22-week fund outflow
Since topping out at a touch above 3%, the 10-year Treasury has rallied in price and fallen to a yield of 2.52%. The rally was kick-started by a surprising delay to the Federal Reserve’s tapering of their QE program in mid-September and is supported by the continued weak growth of the economy. The Fed is meeting this week, though no monetary policy change is expected. Many economists now expect tapering will be delayed until March 2014.
This sustained bond price rally since early September, however, comes in spite of 22 straight weeks of municipal bond fund outflows totaling $48.8 billion. The total outflows over the course of this time period are minor compared to the overall size of the $3.7 trillion market, but serve as an indicator of investor sentiment for the asset class. It is interesting to see that over this time span equity fund outflows have also been negative, even as the S&P reaches new all-time nominal highs. It appears that historically low rates, paired with stock markets at all-time highs, is pushing money to the sidelines reinforcing the reality of an economy continuing to experience anemic growth.
MUB discount disappearance signals stabilizing demand?
ETFs and mutual funds have been victims of the significant fund outflows as they were forced early in the fall to sell composite securities in order to meet redemption demands from fleeing investors. It was reassuring to see the MUB – the most actively traded municipal ETF – trade back to its Net Asset Value (NAV) after trading at a discount for over three months. In this instance sellers were forced to sell at a price BELOW the actual value of the underlying securities. The disappearance of the MUB’s discount may portend stabilizing demand for municipal bonds and is comforting to see from a market volatility perspective.
Watch the Fed this Wednesday for rally signals
Municipal bond rates are inextricably linked to the Treasury market, which is dictated by the Federal Reserve and underlying economic growth. Should the Federal Reserve downgrade their view of the economy in their statement released this Wednesday, expect the above mentioned bond market rally to continue.
Thank you for your continued confidence. Please call us with any questions you may have.
Bernardi Securities, Inc.
October 29, 2013