In the 2Q 2021 issue of our quarterly publication, we:

  • Discuss the how the federal stimulus and vaccination rates have pushed credit spreads tighter
  • Detail the impact the infrastructure plan would have on the economy
  • Note what is likely needed to see the plan move forward

The first half of 2021 continued to produce strong cash flows and positive returns for the municipal market. Fund flows for the year are proving to be the strongest on record, currently at $58 billion, making them the third highest among full-year calendar flows.

As of June month end, the municipal bond market delivered a year-to-date return of 1.24% while the high-yield municipal bond market returned 5.50%. Thanks to a combination of federal stimulus dedicated to municipal issuers and sectors, and increased vaccination rates, we have seen stronger views of the municipal market as credit spreads tightened in all credit and rating sectors. The largest credit spread compression has been in the high-yield and BBB parts of the market as positive fund flows are causing investors to look lower in the credit spectrum in an effort to find attractive yield. As of the end of the first half of 2021, credit spreads for all ratings sectors are at or approaching their historical tight levels, with high yield still offering the widest spread differential to their tights.

Municipal-to-Treasury yield ratios remain very low, after reaching historical highs in 2020. The 10-year moved from 64% to 66% during the second quarter, versus a long-term average of 85%. The 30-year ratio dipped into the 60% range during the quarter, but ultimately ended the quarter steady at 70% compared to a long-term average of 93%. These low ratios indicate municipal outperformance, driven by both technical and fundamental factors.

The summer brings a cyclical lack of new issue supply in the market with July and August maturity and coupon payments providing a supply/demand imbalance. Should fund flows remain strong during this time, furthering the imbalance, we would expect to see credit spreads continue to tighten as maturities and fund flows compete to find attractive yield in the primary and secondary markets. New municipal supply is up 8% as of June 30, with taxable municipal issuance currently accounting for approximately 30% of all new issuance, adding to the imbalance of supply in the tax-exempt municipal market. Changes to tax laws in 2017 reduced the flexibility of municipal issuers to refund tax-exempt debt with another tax-exempt issue forcing issuers to use taxable municipal debt. Combined, these market dynamics could help the overall market continue its trend of credit spread compression and positive returns, in our view.

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