(BlackRock) Municipals posted negative performance in February amid heightened monetary policy and geopolitical uncertainty. Strong economic data and the expectation that the U.S. Federal Reserve would aggressively withdraw support drove up interest rates early in the month before the escalating conflict in Ukraine spurred volatility into month-end.
Attractive valuations helped munis modestly outperform comparable U.S. Treasuries. The S&P Municipal Bond Index returned -0.51% for the month and -2.89% year-to-date. The best performers were shorter-duration munis, which are less sensitive to interest rates, and strategies targeting both ends of the credit spectrum.
Demand remained soft, and February posted the largest net monthly drawdown in mutual fund flows since the pandemic-induced divestment in March 2020. Bid-wanted activity swelled to more than $1 billion per day on average and weighed on the market as investors raised cash to meet redemptions. Amplified headline and statement risk could promote continued outflows over the near-term.
Issuance was modest at $27 billion, 3% below the five-year average, bringing the year-to-date total to $54 billion. Reinvestment income (from maturities, calls, and coupons) outpaced new issues and created net negative supply of nearly $10 billion. Deals were oversubscribed 5.5 times on average, up from 2.7 times last month.
March has been the second-worst performing month of the year over the past five years as issuance usually spikes 16% month-over-month and the market moves to net positive supply. As seasonal dynamics turn less favorable, we expect to proceed with caution, although interest rate shifts and volatility may have more impact on total returns.
Strategy insights
We have shifted to a neutral-duration stance on municipal bond positioning and favor the intermediate part of the yield curve. We prefer an up in quality bias overall while adding select high yield credits amid more attractive prices. We continue to focus on defensive sectors and pay particular attention to bond structures, favoring those with higher coupons and shorter calls.
