In the second quarter of 2024, US Corporate returned -0.09 %, US Aggregate 0.07%, corporate high yield returned 1.09%, and US Treasuries returned 0.09%, respectively.1,2,3,4 In the muni market, returns in investment-grade tax-exempt and taxable returned were -0.02% and -0.19%, respectively, but the high yield market stands out with returns of 2.59% in the high yield tax-exempt market.5,6,7 Furthermore, the muni market continues to perform well despite issuance being up 32% year over year as of the end of June, thanks to the return of mutual fund inflows.8
Remain poised for continued strength
The good news for muni investors, we believe, is that the positive momentum experienced in Q2 is likely to continue this quarter. High yield and lower investment-grade bonds are expected to remain strong performers as credit remains resilient and default activity remains muted. However, we believe there remain areas to navigate cautiously in a higher-for-longer environment:
Beware the belly of the yield curve
While yields are expected to continue declining, we believe investors should remain wary of investing in the belly of the yield curve (maturities in the 3-to-10-year range) (Chart 1).
Chart 1. AAA muni curve remains inverted in the 3- to 10-year portion
As the curve normalizes and steepens, the belly remains vulnerable to underperformance as yields remain more attractive in the shorter and longer parts of the curve. As such, we recommend a barbell approach over the coming period, as this is where investors are more appropriately compensated.
Finding value
The Federal Reserve's (Fed) anticipated easing may not drastically reduce interest rates. We might be entering a period of higher-for-longer rates, making it crucial to find attractive yields elsewhere. Thus, the barbell approach – focusing on both shorter- and longer-term maturities – has proven successful in Q2 and, we believe, remains a solid solution in risk mitigation given our interest rate outlook.
“Buy in May and stay”
Unlike stock investors who might "sell in May and go away," muni investors can benefit from a "buy in May and stay" approach as the technical environment in the summer months is favorable to investors during this time period in most years due to supply-demand imbalance.
We believe favorable technicals will continue in Q3 2024. We expect stable credit fundamentals to lead to outperformance in the lower investment grade and high yield parts of the municipal market through the quarter, as in Q2.
Election-driven issuance shifts
Due to election uncertainty, we believe issuers are pulling their bond offerings forward this quarter. This means a potential uptick in issuance during this period, which could mute the usual technically favorable seasonal effects in the summer months. However, this also presents an opportunity for investors as an uptick in issuance should give investors a chance to get fully invested at elevated yields before a potential Fed cut in late 2024.
With issuance potentially front-loaded in Q3, Q4 might see a quieter issuance environment.
Furthermore, with issuance potentially front-loaded in Q3, Q4 might see a quieter issuance environment. This could be similar to what happened in Q4 2017, following the Tax Cuts and Jobs Act. In that instance, a significant issuance increase in Q4 2017 (up 62% and 38% year-over-year) led to a sharp decline in issuance during the following quarter (Q1 2018, down 54.6% quarter-over-quarter and 28.5% year-over-year).
This period also saw the muni market outperform its fixed income peers (US Aggregate, Corporates, High Yield Corporates, and Treasuries) (Chart 2). More reason for investors to get more fully invested over the Q3 period.
Chart 2. Positive muni performance following a period of significant issuance 2017–2018
Lessons from Q4 2017: Lower issuance can be a positive
The historical example of Q4 2017 (Chart 2) highlights a key takeaway: increased issuance doesn't necessarily translate to negative returns. In fact, that period saw positive relative returns for the muni market, which only improved further when issuance dried up in Q1 2018.
Sectors to watch
We have a constructive outlook on taxable munis. The supply-demand imbalance we observe in the tax-exempt market is even more noticeable in this market. The low primary issuance and issuers using the extraordinary redemption feature to refund outstanding taxable bonds have reduced the supply in this market, boosting valuations in the space.
Furthermore, in this environment, we favor specific credit sectors within taxable munis:
Continuing care and retirement communities
Benefitting from a strong housing market and an aging population, CCRCs see stable resident bases and growing service demand.
Charter schools
Schools with strong academic performance and scale are experiencing increased enrollment and funding, leading to sector stability.
Hospitals
Cost pressures are easing, and hospital profitability is recovering. While reimbursements remain a challenge, attractive valuations present a good opportunity.
The combination of limited supply and high demand suggests continued momentum for taxable municipal bonds, particularly within the highlighted credit sectors.
Final thoughts
Muni investors are entering an interesting period in the latter half of 2024. While the summer typically brings a positive technical environment due to maturing issues and coupon payments leading to higher demand than supply (remember “buy in May and stay”!), 2024 presents a unique twist: the upcoming US presidential election in November.
And while the election might cause short-term fluctuations in issuance patterns, we believe the overall outlook for the muni market in the latter half of 2024 remains positive.
1 Bloomberg US Corporate Bond Index, June 2024.
2 Bloomberg U.S. Aggregate Index, June 2024.
3 Bloomberg U.S. Corporate High Yield Bond Index, June 2024.
4 Bloomberg U.S. Treasury Index, June 2024.
5 Bloomberg Municipal Bond Index, June 2024.
6 Bloomberg Municipal Index Taxable Bonds, June 2024.
7 Bloomberg Municipal Bond High Yield (non-investment-grade), June 2024.
8 JPM Research, June 2024.
Important information
Indexes are unmanaged and have been provided for illustrative purposes only. No fees or expenses are reflected. You cannot invest directly in an index.
High yield securities may face additional risks, including economic growth; inflation; liquidity; supply; and externally generated shocks.
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