In recent weeks, investor concerns over the economic impact from the spread of COVID-19 (Coronavirus) combined with the recent decline in oil prices caused an extreme flight to quality in the Treasury market that sent Treasury yields to historic lows. Credit markets have been negatively impacted as well with corporate bond spreads widening dramatically in response. Until last week, the municipal market was largely unaffected as strong investor demand helped fuel buying, leading to lower yields and positive total returns. That changed last week when municipal mutual fund cash flows turned negative, forcing managers to sell bonds. What resulted was an aggressive and abrupt sell off across the municipal yield curve causing yields to rise sharply. After reaching historic lows, benchmark municipal yields are higher by 0.59%-0.86% (refer to box below). On a relative value basis, municipal yields as a percentage of comparable maturity Treasuries are now at levels well over 100%, a condition that occurs infrequently and has not reached current levels since the Global Financial Crisis of 2008-09. This has resulted in negative total returns year to date of -1%, reversing the positive returns through February.
| 2 YEar | 5 YEar | 10 Year | 30 Year | |
|---|---|---|---|---|
| March 6, 2020 | 0.53% | 0.57% | 0.86% | 1.46% |
| March 13, 2020 | 1.12% | 1.20% | 1.61% | 2.32% |
| Change | 0.59% | 0.63% | 0.75% | 0.86% |
| 2 YEar | 5 YEar | 10 Year | 30 Year | |
|---|---|---|---|---|
| AAA Municipal Yield as a % Treasury Yield - March 13, 2020 |
227% | 170% | 169% | 148% |
| 5 Year Average AAA/Treasury | 77% | 77% | 88% | 98% |
Source: Municipal Market Data. Past performance is not indicative of future results.
The sharp rise in yields experienced in the municipal market over the past week is highly unusual and is a result of the extreme volatility that has occurred in the markets since the outbreak of the coronavirus. It is important to remember that this selloff is technically driven and stems from mutual fund redemptions and the related forced selling and is not the result of credit concerns in the broader municipal market. Negative economic growth is very likely to result from the closures and cancellations across the country, which will reduce tax receipts and generally have a negative impact on municipal finances. Municipalities, however, were in good shape coming into this crisis following years of positive economic growth, which allowed many to build financial reserves. While it is difficult to know the outcome and the ultimate economic impact, the hope is that the measures taken by both government and health officials will stem the spread of the disease and ultimately limit the economic impact. Over the near term, however, volatility is likely to continue until a clearer picture on the outcome of the virus emerges.
It is helpful to remember that client municipal portfolios are invested conservatively in high quality, intermediate maturity bonds with the primary goal of preserving capital. We feel that municipal investments will continue to fulfill that role. The market disruptions that have occurred over the last few weeks have created many “cheap” investment options for investors across different sectors. Historically, however, when municipals reach levels comparable to current valuations, the sector typically performs well over the following months and current municipal valuations provide an attractive entry point, especially when compared to the absolute and relative levels seen only a couple weeks ago.
