March’s bout of geopolitical volatility affected investment approaches of all kinds, and municipal bonds were unfortunately no different. As just one example, the Bloomberg Municipal Bond Index fell more than 2% on the month, as the fixed income asset struggled to retain its safe haven reputation.
Key Takeaways:
- Despite struggling in March, the municipal bond market has far too much going for it for advisors and investors to back out already.
- The overall fundamentals for munis remain relatively sound, especially in terms of credit, technicals, and historical precedence.
- For those choosing to increase municipal bond exposure, Blackrock recommends a barbell yield curve strategy, favoring the transportation, housing, and corporate sectors.
That being said, one month of weaker performance doesn’t necessarily tell the whole story. For instance, it’s not like municipal bonds were the only safe haven asset to struggle in March — gold also saw its relative momentum come to an abrupt end.
Of course, understanding why a traditional low-risk asset faltered in a time of geopolitical uncertainty is crucial. After all, municipal bonds are the kinds of assets that advisors and investors usually like to turn to in times like these.
BlackRock's Take on the Muni Market
Recently, members of the BlackRock team addressed the state of play for municipal bonds, in BlackRock’s latest Municipal Market Quarterly Update. In fact, the report began by assessing what went wrong with the municipal bond market in the month of March.
“The macro backdrop shifted materially in March, as an oil-driven inflation shock tied to escalation in Iran prompted a sharp repricing of monetary policy expectations—from anticipated rate cuts to potential hikes,” the BlackRock report noted. “This shift triggered elevated volatility and a reversal of earlier gains, compounded by a pickup in issuance and softening demand amid fund outflows and weaker reinvestment support.”
See More: After A Rough March, Muni Bonds Still on Firm Ground
In essence, the BlackRock team assessed that the municipal market’s strong start to the year was upended by a sharp repricing when conflict arose in the Middle East. As the Strait of Hormuz closed and oil prices began to rise, worries of inflation mounted, making the muni environment much weaker.
Why It's Too Early to Give up on Munis
However, BlackRock asserted that the municipal bond market remains on solid footing in terms of fundamentals. Credit remains solid, and the overall technicals for the muni market remain appealing. Regardless, being a little more choosy with one’s sector exposure, and potentially taking a more defensive stance, may pay off in the coming months.
Let’s take this a step further. As BlackRock noted, the Municipal bond market traditionally does quite well in the summer months of June, July and August. During this time in particular, reinvestment demand is high while new supply is low. Should fundamentals continue to back the muni market, advisors and investors alike could be seeing quite the comeback for munis in the coming months.
Historical precedent could also be working in favor of munis. BlackRock noted that municipal bonds tend to rebound quickly following event-driven sell-offs. Notably, in the last five event-driven sell-offs since 2020, the muni market has been able to recapture about 50% of its drawdown within five trading sessions on average.
“Against this backdrop, we believe valuations are becoming more compelling and may represent a desirable entry point for deploying capital,” BlackRock added. “Should global uncertainties begin to subside, the combination of strong technicals and solid fundamentals could support a meaningful rebound in performance.”
See More: Modernize Fixed Income Portfolios With Income Alternatives
Seeking the Best Muni Opportunities
Of course, choosing which municipal sectors to invest in could very much matter in the long-term. The firm recommended leaning into the transportation, corporate, and housing sectors in particular. Additionally, BlackRock’s approach favored a barbell yield curve strategy, leaning into 0–5-year and 15–20-year segments of the muni market.
March may have scared some investors away from municipal bonds, but their solid fundamental and historical merits should keep them highly relevant in fixed income portfolios in the months to come. After all, when advisors are looking to build tax-exempt income and navigate a potentially volatile environment, it’s hard to go wrong with what municipal bonds can bring to the table.
Originally published on Advisor Perspectives
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