Issuers are exhibiting a pronounced inclination to expedite their bond offerings – a trend we believe is likely to amplify issuance volumes and potentially offset the normally favorable seasonal conditions (see "Buy in May and stay ").
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. An uptick in issuance should allow investors to get fully invested at elevated yields before a potential dry spell in issuance and a potential US Federal Reserve (Fed) cut in late 2024.
"Buy in May and stay"
Historically, the summer months have been characterized by an issuance imbalance between overwhelming demand created by maturing and called bonds looking to be reinvested and underwhelming supply, creating a supply-constrained environment that often supports bond prices. Unlike stock investors who might "sell in May and go away," we believe 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.
However, we believe the current market conditions are diverging from this established pattern.
Shifting dynamics
Several key factors are converging to drive issuers to accelerate their borrowing plans:
- Fiscal uncertaintyThe prolonged period of interest rate hikes by the Fed has created a challenging landscape for issuers. By bringing forward their bond offerings, municipalities can lock in financing and mitigate the risks associated with fiscal uncertainty by front-loading their issuance before the election. This creates an opportunity for investors to lock in high-income opportunities.
- Market uncertaintyThe specter of an economic downturn looms large, casting a shadow over the municipal bond market. Issuers are concerned about potential revenue shortfalls as their robust balance sheet liquidity has peaked. By securing funding now, they can enhance their financial resilience and mitigate risks associated with future economic challenges.
- Infrastructure spendingThe essential role of municipalities in providing essential services and infrastructure makes the sector a cornerstone of fixed income portfolios.
The combination of economic uncertainty, election outcome ambiguity, and increased infrastructure spending is creating a compelling environment for front-loaded issuance.
The substantial influx of federal funds allocated for infrastructure projects has created a surge in municipal capital expenditure plans. To capitalize on these opportunities, issuers are accelerating their bond issuance to finance these projects, leading to a concentrated wave of supply in the market.
Carpe diem
The confluence of these factors is expected to result in a significant uptick in muni issuance this quarter. While this surge in supply may temporarily dampen relative performance, we believe it also presents a compelling investment opportunity. Investors can benefit from the potential to acquire bonds at higher yields, which can provide attractive returns over the long term.
Moreover, the Fed has signaled a potential shift towards monetary policy easing later this year. As interest rates decline, the value of existing munis is likely to appreciate. By increasing bond holdings during the period of elevated issuance, investors can position themselves to benefit from the potential price gains associated with a rate cut.
Q4 2017: A history lesson
With issuance potentially front-loaded in Q3, Q4 might see a quieter issuance environment. This could be similar to Q4 2017, following The Tax Cuts and Jobs Act.1 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 by 71 basis points (bps) in investment grade and 287 bps in the high yield category (US Aggregate, Corporates, High Yield Corporates, and Treasuries) (Chart 1).2 Thus, we believe it is only more reason for investors to get more fully invested over the quarter.
Chart 1. Positive muni performance following a period of significant issuance, 2017–2018
Final thoughts
The historical example of Q4 2017 (Chart 1) highlights a key takeaway: increased issuance doesn't necessarily translate to relative returns. That period saw positive relative returns for the muni market, which improved further when issuance dried up in Q1 2018.
The accelerated pace of municipal bond issuance in Q3 presents a dynamic market environment. While the surge in supply may temporarily impact bond prices, it also offers investors an opportunity to acquire bonds at attractive yields.
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 The Tax Cuts and Jobs Act of 2017 allows a tax credit for employers that provide paid family and medical leave to employees.
2 Bloomberg, July 2024. "Investment grade" compares Bloomberg Municipal Index to Bloomberg Aggregate Index, "High yield" compares Bloomberg High Yield Municipal Bond Index to US High Yield Corporates.
Important information
Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.
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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