A Rare July Slide
State and local government bonds are heading toward their worst July performance in over 20 years. The roughly $4 trillion market usually counts July among its strongest months. Through Thursday, the Bloomberg Municipal Bond Index was down 1.72% for July, making it the worst July since 2003 and just the second month to post a loss this year. The earlier drop occurred in March, when the Iran war began and oil prices jumped.
The loss comes after a strong first six months, in which munis beat other fixed-income assets. It also marks a departure from the so-called summer technicals that normally bolster the market. In a typical July, munis rise because investors reinvest billions from coupon payments and redemptions that arrive in the middle of the year. Issuers also often avoid selling debt in the summer, and that seasonal lull has usually been a tailwind for prices.
New debt sales came to roughly $47 billion this July, a higher total than is typical for the month. The new bonds landed just as inflation worries were driving long-term Treasury yields toward a 19-year high, and the impact spread throughout the fixed-income universe.
That period drew steady demand for tax-exempt income, and the demand had made these bonds pricey. When supply and Treasury yields moved against the market, the adjustment was swift.
What It Means for Investors
Leslie Martin, a money manager at Cavanal Hill Investment Management, said the combination of heavy supply and rising Treasury yields has been difficult for the market to digest.
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“The market has had to absorb a lot of issuance while Treasury yields have moved higher, which has created pressure on prices and led to some unusually weak performance for a month that is typically supported by strong reinvestment demand,” Martin said.
Martin added that the selloff has more to do with adjusting valuations to a higher-rate world than with concern about muni creditworthiness, and that this may open up buying possibilities.
“The silver lining is that the selloff has improved valuations and increased the income investors can lock in today,” she said.
The recent weakness, however, has pushed state and local government bonds to near their most attractive relative valuations of the year.
The Outlook
Matthew Gastall, who runs municipal strategy and research at Bloomberg Intelligence, noted that a monthly drop of more than 1% is not rare across the broader market, though it is unusual during the summer.
“When viewing the market broadly, a one-month decline of over 1% isn’t uncommon, but it’s notable for a summer session,” Gastall said.
Gastall also cautioned that sufficiently low muni-to-Treasury ratios could leave municipal bonds more vulnerable to interest-rate moves.
Eric Kazatsky, who holds the title of managing director at Mackay Shields, said investors who missed last year’s gains can now secure more attractive long-term rates.
“This is really a second bite at the apple in terms of locking in longer-term rates,” Kazatsky said.
Still, those higher yields are the flip side of the rate moves that triggered the selloff. With long-term Treasury yields pushed toward a 19-year high, investors are balancing the income on offer against the risk that additional rate increases could push municipal bond prices lower.
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