In the 1Q 2021 issue of our quarterly publication, we:

  • Discuss the muni market’s outperformance versus fixed income during 1Q 2021 amid volatility
  • Note the potential challenges that could lie ahead
  • Share our views on the potential improvement on the credit quality of New York State, New York City and the MTA

Municipals outperformed other fixed income asset classes during the quarter ended March 31 as robust demand boosted by an improved outlook for municipal credit kept yields low despite a sharp rise in U.S. Treasury rates.

Anticipated federal largesse, which materialized in early March in the form of The American Rescue Plan Act (ARPA), narrowed credit spreads and buoyed municipal investor sentiment, fueling demand in the first quarter of 2021. Weekly and monthly fund inflows through March 31 were the fastest on record, totaling $31.7 billion.

Municipal credit received a substantial lift from the $1.9 billion ARPA, including $350 billion targeted to state and local governments. Municipals’ rosier credit outlook is further reinforced by expected increases in tax revenues as state and local economies improve, aided by rising vaccine distribution.

Counteracting these first-quarter tailwinds for the municipal market, Treasuries suffered a sharp sell-off from January to March, due to heightened inflation fears. Tax-exempt municipal rates initially lagged Treasuries but joined the selloff in late February before staging a partial recovery.

A volatile quarter

In January, municipal valuations grew extremely rich and were, as some said, priced for perfection. Legislative progress on the ARPA drove municipal credit spreads tighter, especially among credits in the lower ranges of credit quality. Meanwhile, taxexempt supply remained low, while demand continued to increase. The S&P Municipal Investment Grade Bond Index produced a total return of 0.47% for the month, while the U.S. Treasury Index returned –0.96%.

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