Strong Finish for Muni Markets in 2016
TOM BUTCHER: Jim, how has the municipal bond market performed so far this year?
JIM COLBY: The municipal market has performed exceedingly well, given that expectations were for perhaps modest gains this year. We started 2016 with uncertainty about what the Federal Reserve was going to do, and uncertainty about the economy, which made it impossible to predict exactly what performance was going to be this year. On balance, I would say that we have had good performance year to date.
BUTCHER: What has muni investment flows been like, especially in light of recent money market fund reforms?
COLBY: Municipal flows can be broken down in two ways: there is supply and there is demand. Demand flows have been extraordinary. For the better part of the past 52 weeks, we have had inflows into the municipal market. In terms of the flows of new issues into the marketplace, however, there has been an imbalance: not as much supply as there has been demand. This dynamic has led to strong performance in 2016. Of late, however, we have seen a reversal of this trend, with slight outflows in the municipal space and a tidal wave of new issues coming into the market. That might sound a little daunting, but it has been a beneficial event for the municipal marketplace because, suddenly, we now have plenty of supply to meet demand, which I believe will resurface in this fourth quarter.
BUTCHER: Has recent volatility altered your expectations for the rest of the year?
COLBY: My expectations are still fundamentally positive. I think that the sudden surge of new supply into the market has reset yields higher. From an investor's standpoint, this represents an opportunity to reenter the marketplace at more attractive levels than have been available over the last two or three months, or even in the third quarter. Looking at the fourth quarter, I do not see anything that is going to change the opportunity set in municipals. The ratios of municipal yields compared to U.S. Treasury yields, the basic analysis of what represents value in the municipal marketplace, are now pushing upwards of 98%-99%, and in some cases 100%.1 When municipal yields are yielding the same as U.S. Treasuries that indicates great value. In the fourth quarter, this value will underpin an opportunity that people will recognize again. I believe that we will have a pretty good finish to the fourth quarter, whether or not the U.S. Federal Reserve raises interest rates.
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1 As of 10/31/2016. Source: Thomson Reuters and Bank of America Merrill Lynch.
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