As coronavirus-related market volatility expands into municipal bonds, the Franklin Municipal Bond Department explains how they are navigating an increasingly challenging muni-market environment. They also share reasons why they believe a longstanding preference for high-quality municipal bonds supports their efforts to turn volatility into opportunity.

As volatility due to the global coronavirus outbreak picked up across financial markets in late February and into early March, the municipal bond market seemed relatively impervious at first. Then, during the second week of March, the muni market experienced one of its worst single-day price declines over the last decade.1

In our view, it’s premature to predict the full impact of the coronavirus outbreak on society and the US and global economies until the impacts of the COVID-19 pandemic are behind us. However, as the global market turmoil has carried over into munis—a unique corner of the US fixed income market—we wanted to highlight some of the key factors that have rapidly combined to create a much more volatile investment environment, one that we believe our strategies are relatively well-positioned to navigate.

In the United States, the recent selloff in municipals has felt similar to the global financial crisis just over a decade ago, with US Treasuries seemingly presenting the only safe haven in the minds of many investors.

Although uncertainty related to the coronavirus outbreak has been the main reason for muni-market volatility, we have seen a number of other contributing factors as well.

For example, the oil shock that began to hit corporate bond markets in late February and has since gained steam, has started to play a more meaningful role in the municipal market. Another key factor contributing to the recent declines is the fact that the municipal market has recently transitioned to net redemptions after experiencing record cashflows in 2019 and the first two months of 2020. The entire municipal market has sold off, but this may be one reason why high yield has been hit hardest, a risk we highlighted in detail in a previous article in January.

After returning 4.62% for the year-to-date (YTD) through February, the Bloomberg Barclays High Yield Index returned -8.67% during the week of March 9, leaving YTD returns at -4.68% as of 3/13/20.2