Municipal Summary
Fundamentals continued to weigh heavily on fixed-income markets yesterday. Rising oil prices, higher energy costs and related inflation concerns – along with the prospects for a more restrictive vs. accommodative Fed, even under new leadership – pressured Treasury yields 5-8 bps higher across the curve. Meanwhile, tax-exempts incurred their fifth largest daily price loss of the year, falling -0.53% across a slightly flatter curve, and are now down -1.37% MTD (vs. a 0.71% average May gain over the last 15 years). So it has been a challenging start to an otherwise supportive period in the year; where participant uncertainty and angst related to geopolitical headlines, inflation and the Fed have generated volatility and risk-off behavior, but in the context of higher correlations between US equities and rates.
However, for the municipal market, while it is true that 1) benchmarks are being cut more aggressively this week, 2) daily price volatility has edged higher, 3) bid/ask spreads have widened, 4) consensus on clearing levels is low, 5) new allocations lack the same conviction from earlier in the month, and 6) there is growing concern fund outflows materialize after recent NAV declines, the recent move has been generally orderly. Bids are cheaper but not by outrageous amounts, the primary calendar is still going away, dealer inventory levels are not yet concerning, there has been no evidence (yet) of outflow pressure, and the market is still in a seasonal period of rising reinvestment demand to support distribution. Recall, too, high-grade taxable equivalent yields are now well above 5.0% >10yrs in a market still dominated by a retail/SMA/income-oriented buyer. Furthermore, technical levels are trending toward "oversold" for total-return accounts.
It has indeed been a challenging week with spots of illiquidity and adversity; but a move to higher yields in an orderly manner can be more easily embraced – especially if reinvestment demand continues to climb, outflows stay manageable, and the street/media begin to highlight a narrative of higher income opportunities for a fundamentally strong asset class.
Municipal Returns
IG Maturities (%): Duration got hit — 22+yr is down -1.28% MTD and -1.26% over 3 months, while the 1yr bucket is essentially flat, a reversal from long-end outperformance seen in prior weeks.
HY Maturities (%): The short end is holding up (1yr +1.87% YTD) while the long end is under pressure, with 22+yr down -1.24% MTD and -1.56% over 3 months.
IG Credit (%): A broad selloff erased most YTD gains — indices are barely positive YTD, with Education the only sector negative at -0.06%, while Transportation (+0.41%) is the relative standout.
HY Credit (%): Housing is deeply negative at -1.12% YTD and -3.26% over 3 months, underperforming Hospital (+2.17%) and PR (+1.90%); Transportation (-5.51% 1yr) and Tobacco (-3.79%) remain the laggards.
Credit Returns (%): Nearly everything has sold off MTD, with Treasuries (-1.65%) and MBS (-1.45%) hit hardest; only HY Corp, EM HY, Lev Loans, and HY Munis remain positive YTD.
MUNISTREET Model Performance
Below is the YTD performance of MUNISTREET's Model Portfolio through 5/19, which went short MUB following last Tuesday's (5/12) session. For reference, the model is a long/short strategy using technical signals to toggle positioning between long and short MUB. The model has generated ~7.0% annualized returns, a 1.16x Sharpe ratio, no negative calendar years, and average annual max drawdowns under 3%. Trades are roughly evenly split between long and short days, with alpha generated in both rising and falling rate environments.
Note, no actual trading is taking place; the model is simply updated and tracked in Excel.
Macro/Rate Summary
NY Fed services business activity at 16-month high (-5.8); employment turned positive first time since last summer.
NAHB homebuilder sentiment rebounded modestly to 37 (vs 34 expected) but remained in contraction.
30Y at post-2007 high; foreign holdings of US Treasuries fell $138.4bn in March on valuation losses; China holdings at multiyear lows.
Japan 10Y JGB rose for 9 consecutive days; nominal JGB yield now above dividend yield.
Barclays "No saving grace": four developed bond markets broke ranges simultaneously — too much debt, no fiscal discipline; sees Brent averaging $100 in 2026; sees nothing magical about 5% on US 30Y; marginal Treasury buyer now price-sensitive private investor demanding term premium.
BMO: oil remains the biggest driver of the macro narrative despite attempts to broaden.
DB: 4 conditions for a bigger risk selloff not yet in place — oil curve still in backwardation, global data still upside-surprising, no aggressive central bank response yet.
Morgan Stanley Market Sentiment Indicator flipped negative (risk-off) after holding positive since April 27; still overweight equities 12M with US preference.
BofA Global Fund Manager Survey: equity allocations boosted by record amount in May.
Apollo: AI now ~50% of IG issuance, 87% of VC funding, and a growing share of HY issuance.
10Y Treasury yield now exceeds S&P 500 earnings yield by most since early 2002.
Equities historically post sharp drawdowns in first three months of a new Fed Chair's term; midterm years see largest intrayear pullbacks.
China April crude processing fell sharply as Hormuz disruptions forced state refiners to multiyear-low run rates.
US net investment income surplus nearly erased post-pandemic on higher rates and continued foreign US asset purchases (NY Fed).
UK unemployment rate unexpectedly rose; HMRC payrolls posted steepest fall since the pandemic.
Tripp Kaiser, CFA, is the founder of MUNISTREET, Executive Director of the Center on Municipal Capital Markets, and a professor of practice at the LBJ School of Public Affairs at the University of Texas at Austin.