- Tax-exempt municipal bonds generated solid performance in January, with high yield munis gaining more than 2% on the month.
- Municipal yields rose early in the month on expectations for higher rates and additional fiscal stimulus.
- Although issuance was relatively light in January, the municipal market experienced strong demand, with four consecutive weeks of fund inflows.
January Month in Review
The stock market experienced a volatile January, with major U.S. equity indices reaching record highs mid-month and subsequently closing the month flat to slightly down following a flurry of retail investor activity.1 The U.S. fixed income market also experienced a relatively lively month; both Treasury and municipal yields jumped notably over the first full week of the new year. The rally was due in part to rising rate expectations, as well as Democrats’ success in resuming control of the White House and Congress, with implications for additional fiscal stimulus. In the weeks to follow, relatively low issuance, coupled with persistent inflows, pressured municipal yields downward.
As is often seen in January, supply/demand dynamics in the municipal market generally favored demand, with reinvested cash from maturities and calls outweighing new issuance. Market participants witnessed four consecutive weeks of municipal fund inflows amidst a relatively light month of issuance. $26.7 billion came to market in January, $9.4 billion of which was taxable.2* The 10-year tenor of the AAA Municipal Market Data (MMD) ultimately closed the month at 72 basis points (bps), up one basis point from December’s close. By contrast, tenors inside of three years ended January down 3–4 bps, while remaining tenors experienced shifts from -1–2+ bps.3
- Following January’s meeting of the Federal Open Market Committee, the Federal Reserve announced that no changes were made to the current monetary policy strategy. Federal Reserve Chair Jerome Powell remarked that “the pandemic still provides considerable downside risks to the economy,” and signaled support for additional Congressional spending measures to support struggling households and businesses. However, the Fed does estimate that U.S. economic output will grow 4.2% in 2021, while the unemployment rate will decline to 5% as the COVID-19 vaccine rollout continues.4
- Tax-exempt municipal bonds closed the first month of the new year with positive performance. The Bloomberg Barclays Municipal Bond Index returned 0.64% in January, while the Bloomberg Barclays High Yield Municipal Bond Index was up 2.09%. Taxable munis were down slightly, however, with the Bloomberg Barclays Taxable Municipal Index posting a 0.03% loss.5
- The Treasury yield curve experienced a bear steepener in January, as long-term rates rose faster than short-term rates. This ultimately led to further tightening in municipal/Treasury taxable-equivalent spreads.** At month-end, taxable-equivalent spreads equated to 7 bps at the one-year tenor (down from 11 bps), -7 bps at the five-year tenor (down from 1 bps), 14 bps at the 10-year tenor (down from 28 bps), and 49 bps at the 30-year tenor (down from 70 bps).6
Following a relatively active December, secondary market trade volume declined by 5.5% in January. Trades for the month totaled just over 621,000 (down from ~657,000 in December) while par traded amounted to $173 billion (down from $193 billion).7
Muni technicals in focus: ‘January effect’ kicks off the year to a strong start
For the municipal market, the first month of the year is typically characterized by elevated demand, largely attributable to reinvestment capital, coupled with a slowdown in issuance. Over the last two decades, the municipal market has posted negative returns in a January only 4 times.8 This year, the seasonal ”January effect” drove strong municipal technicals yet again, as the Bloomberg Barclays Municipal Bond Index posted a 0.64% monthly return.9 With municipal credit spreads continuing to tighten and municipal investors willing to take on marginal risk for additional yield, the Bloomberg Barclays Municipal High Yield Index returned 2.09%.10,11
Despite the low rate environment, municipal issuers continue to weigh the impacts of the evolving COVID-19 situation and the potential for federal aid. Monthly municipal new issuance was $24.02 billion, down by more than 25% from last January’s volume.12 Meanwhile, municipal funds reported three consecutive weeks of $2+ billion in inflows, as retail municipal investors poured ~$8.87 billion* in municipal funds in January.13 This supply/demand imbalance suppressed municipal yields, which did not move upwards in conjunction with Treasuries. Although the 10-year Treasury yield climbed 16 bps in January to 1.08%, crossing the 1% threshold for the first time since March, the 10-year AAA municipal yield closed the month roughly flat at 0.72%.14 The 10-year municipal/Treasury ratio now stands at ~67%, suggesting the most expensive municipal valuation relative to Treasuries since 1984.15
January’s credit news was dominated by changes in federal policy implemented by the new administration and renewed hopes for further stimulus legislation. The Biden administration took several executive actions that will provide immediate help to state and local governments, including announcing full FEMA reimbursement for a variety of pandemic related costs, such as local governments’ personal protective equipment purchases and states’ costs of deploying National Guard troops to aid in the vaccination process.
Additionally, the U.S. Department of Health and Human Services notified governors that the current public health emergency will likely remain in effect through 2021, which paves the way for a continuation of the federal government’s increased Medicaid cost-sharing, as well as targeted Medicare enhancements originally included in the CARES Act through the remainder of the year. This announcement benefits both non-profit hospitals and states whose budgets are heavily influenced by Medicaid expenses.
On the heels of the Trump administration’s December $910 billion spending package, which included significant support for parts of the municipal market, President Biden has pushed an even more aggressive $1.9 trillion pandemic relief package that includes $350 billion in direct support for state and local governments. With many states weighing spending cuts in their upcoming budgets, additional federal assistance would likely result in reduced austerity measures.
1 Caitlin Ostroff, “Stocks Climbed as Online Traders Send Silver Soaring,” Wall Street Journal, 1 Feb 2021↩
2 The Bond Buyer: Primary Market Statistics – A Decade of Bond Finance, 31 Jan 2021; Bloomberg, 3 Feb 2021↩
3 Thomson Reuters TM3 MMD Interactive Data, 31 Jan 2021↩
4 Jon Hilsenrath, “Fed Holds Policy Steady as Economy Stumbles,” Wall Street Journal, 27 Jan 2021↩
5 Bloomberg Barclays, 29 Jan 2021↩
6 Thomson Reuters TM3 MMD Interactive Data, 31 Jan 2021↩
7 The Bond Buyer: Secondary Market Data, 2 Feb 2021;↩
8 Bloomberg Barclays, 29 Jan 2021↩
10 Thomson Reuters TM3 MMD Interactive Data, 29 Jan 2021↩
11 Bloomberg Barclays, 29 Jan 2021↩
12 The Bond Buyer, “Bond Sales (Latest Month)”, 29 Jan 2021↩
13 Refinitiv Lipper, 27 Jan 2021. *Data is inclusive of weekly reporting funds and does not include monthly reporting funds.↩
14 Thomson Reuters TM3 MMD Interactive Data, 29 Jan 2021↩