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June 9, 2022  |  3 Minute Read

By: Scott Diamond, Matt Wrzesniewsky


The municipal market is generally known for its steady returns and relatively low volatility—this year has been different. A sudden shift in The Fed’s policy toward more aggressive interest-rate hikes has prompted investors to pull money out of municipal mutual funds in 2022 at a near-record pace, in line with the approximately $70 billion worth of outflows that followed the 2013 Taper Tantrum. This has all but reversed the record inflow seen in 2021.


The Fed’s hawkish turn has pushed up yields and pushed down prices of nearly all types of bonds, munis being no exception1. But once the market stabilizes, investors will have an opportunity to reinvest at higher yields, locking in higher income and return potential. For most investors, though, the tricky part is deciding when to wade back in.



Exhibit 1: Change in Yield...Change in Fortune?

Sharp Spikes in Yields are Rare and Create Opportunity for Investors

Past performance does not guarantee future results, which may vary. The value of investments and the income derived from investments will fluctuate and can go down as well as up. A loss of principal may occur.



The month of May was the first month of positive returns for the municipal market since December 2021. The market returned +1.49% in May after a sudden reversal in sentiment mid-month after index yields hit 3.5%—roughly 5.9% on a tax-equivalent basis for investors at the highest tax bracket—and a reminder that there are now attractive potential alternatives to riskier assets.


The question lingering in many investors’ minds today is the age old one: are we there yet? While answering that question definitively is impossible, we do believe there are signs of stabilization and light at the end of this tunnel. With municipal yields at 10-year highs, we’ve started to see the market rally. There may be more ahead.


One reason is that market technical factors such as issuance and coupon payments have historically lent support in the summer months. We estimate $45.9 billion in coupon payments will hit the market from June through August. At the same time, we expect net new issuance to be negative, reducing supply for at a time when those coupon payments will need to be reinvested and $127 billion of bonds are called or are set to mature.


Also, credit health remains strong despite recent market volatility, bolstered by positive economic growth that has lifted tax revenues for states and local governments. Rainy day fund balances have swelled and the extra cash has led municipalities to meet their necessary pension contributions. For fiscal year 2022 rainy day balances are $100 billion, just shy of the record set for fiscal year 2021. And as we move through budget season, states are indicating surpluses, and some more than forecast. California has reported of nearly $100 billion of surplus revenue2. Both Texas and Florida also boast of sizable budget surpluses of $20 billion, respectively. And lastly, the backdrop has benefited BBB-rated Illinois with the first ratings upgrade in approximately two decades.


With some much anticipated relief for muni investors in May and signs that outflows may be slowing, municipals look attractive at current valuations, and we think they offer attractive income on both an absolute and tax-equivalent basis. Past periods of disruption have been fruitful entry points for long-term investors. With higher yields and a stable fiscal backdrop, municipals may not be on sale for long.



About the Authors

Scott Diamond

Co-Head of Municipal Fixed Income

Scott Diamond

Matt Wrzesniewsky

Fixed Income Strategist

Matt Wrzesniewsky

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1 Hawkish: Phrase used to explain the aggressive tone of the Federal Reserve, indicating that the Fed believes that the inflation rate is high enough to warrant concern.

2 Source: The California Legislature’s Nonpartisan Fiscal and Policy Advisor, Florida Governor Ron DeSantis’ website, Texas Comptroller’s office. 



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Past performance does not guarantee future results, which may vary. The value of investments and the income derived from investments will fluctuate and can go down as well as up. A loss of principal may occur.

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Date of first use: June 8, 2022


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