The municipal bond market exhibited a phase of relative stability as it entered a Thanksgiving-shortened trading week. Observations point to a lean in activity, attributed to a combination of robust technical factors and a reduction in supply dynamics. For the ninth consecutive session, yields on triple-A rated securities remained effectively unchanged, while U.S. Treasury bonds marked slight fluctuations: small losses on shorter durations along with modest gains for those with longer maturities. Peter DeGroot, a leading figure at J.P. Morgan’s municipal research division, remarked on the substantial outperformance of municipal bonds this month, evident across various maturities as the market shifted into a more favorable technical environment.
The prevailing sentiment among investors appears cautious yet optimistic. A significant decrease in new supply has afforded dealers a moment to regroup, with inventory levels dropping noticeably. There is a distinct lack of apprehension from retail investors towards fluctuations in interest rates, lower taxes, and the looming uncertainties tied to tax-exempt securities. Mikhail Foux, from Barclays, pointed out that despite some negative tension regarding tax-exempt ratios, a solid influx of investment into tax-exempt bonds continues unabated. This ongoing demand reflects a healthy commitment to the municipal bond market amid external pressures.
Data stands testament to these ratios; as of Friday, the two-year municipal bonds equated to 60% of their Treasury counterparts. The five-year ratio slightly elevated to 62%, the ten-year positioned at 66%, and impressively the thirty-year ratio reached 82%. Such metrics indicate that while the immediate outlook for the municipal sector remains benign, pursuit for performance might have dwindled owing to perceived unattributive ratios hampering trading activities.
As November draws to a close, market expectations lean positively, particularly towards December—a historically strong month for municipal performance. Bloomberg’s Municipal Index reflects an enticing 0.85% return for November and a year-to-date return of 1.66%. High-yield (HY) securities have followed this positive trend closely, recording November returns of 1.02%, culminating in an impressive 6.92% year-to-date return. However, taxable municipals have faced headwinds, mirroring losses this month at -0.27%.
Foux emphasized the strong foundation for municipal performance in December, as historical data illustrates high-grade municipalities maintaining average monthly returns of 0.9% over a decade. Yet, the high-yield sector remains more erratic, characterized by a mixed performance trajectory in comparison. The cautious optimism among investors aligns with an overarching view that December will generally reflect typical market exuberance associated with end-of-year trading.
Beyond the confines of the municipal market, macroeconomic indicators reveal resilient growth trends in the U.S. economy. The core Price Consumer Expenditure (PCE) index from Q3 will be a point of focus moving forward, as this will provide valuable insights leading into the Federal Open Market Committee’s next policy-setting meeting. Current futures pricing anticipates a modest 25 basis point rate cut, yet uncertainty persists with only a 55% probability this outcome might transpire.
Foux’s assertion highlights that a stabilizing macroeconomic environment, underpinned by an anticipated GDP growth of 2.8% for Q3 2024, diminishes the likelihood of any immediate economic downturn. However, he remains cautious about the trading landscape for 2025, where challenging conditions might persist—suggested by valuations that might not appear attractive against historical backdrops.
As we anticipate the beginning of December, the historical propensity of municipal bonds to outperform remains ingrained in investor consciousness. Insights shared by both DeGroot and Foux underscore that the current yield levels still appear relatively appealing, particularly against historical ranges from the preceding three years. Long-dated municipal securities continue to show strong attractiveness, benefiting from the favorable net-supply backdrop.
Investors are urged to adopt a cautious yet optimistic stance as the market progresses. Should stability persist, particularly in interest rate conditions, there lies a significant potential for municipal bonds to navigate towards rich valuations in December and beyond. The market’s resilience post-election years and consistent patterns of December performance continue to reinforce the attractiveness of the municipal sector despite the ever-evolving economic climate.