Transcription:
Chip Barnett: (
Hi and welcome to another Bond Buyer podcast. I'm Chip Barnett and I'm here today with my colleague, Gary Siegel and he's a managing editor at The Bond Buyer. Our guest today is Daniel Berger. He's the senior municipal strategist at Refinitiv Municipal Market Data. And we're gonna be looking at 2022 — back at what happened in the first half of the year and ahead to what may happen in the second half. Welcome Daniel.
Daniel Berger: (
Thank you. Thank you for having me. Great to be here.
Chip Barnett: (
Why don't you start off by telling our listeners what happened in the municipal bond market in the first six months of this year? You know, it's really been very volatile.
Daniel Berger: (
Well, there's been, as you mentioned, a lot of volatility, the municipal bond market has underperformed treasuries and the ratios have gone up, but nonetheless, the munis are still remain highly correlated to treasuries. And there's been a noticeable outflow of funds from municipal bond funds. There've been steady outflows in contrast to last year when there were inflows. And that pretty much summarizes what's been happening in the mini market.
Gary Siegel: (
Economic data have been softening, suggesting the economy is slowing. Is that what you've seen and expect it to get worse?
Daniel Berger: (
Well, in the municipal bond market, it's, it's kind of a paradox in that we've seen. What I haven't mentioned is that there have been more upgrades than downgrades yet. We've seen spread widening and there's been collateral damage for muni bonds. As a consequence of what's been happening in the in the treasury market, there's been a flight to quality and munis have underperformed treasuries, which have really outperformed. And that's been the, that's been the favorite invest investment for investors in fixed income. And that's a lot of what we've seen.
Gary Siegel: (
But what about the economy in general? What are you seeing there?
Daniel Berger: (
Well, you know, there's usually a lag with, with munis and you really don't see the impact of the economy on municipalities yet because their finances — they're gonna start reporting their finances for the middle of the year and you might see those in September. So, in terms of what the impact has been thus far it's kind of good, because as I've mentioned, for the states, for example, there have been 12 rating actions that we've seen either outlooks or ratings themselves and they're all been positive. So it's been in a positive direction. That's what the impact of the economy on munis is , that we've seen a positive credit outlook is really what we've seen so that I hope that answers your what your question.
Gary Siegel: (
If the economy should slow and most economists see it slowing, how will that impact municipal bonds?
Daniel Berger: (
Okay, Gary, thank you for asking that question. That's something we've actively considered in terms of how the market, the muni market will respond. Should there be a recession we've closely watched the treasury market because munis are so correlated to treasuries in the treasury market. In the spring of this year, we saw that the two to 10 year slope of the yield curve was inverted. That was the first time it was inverted since 2019. That telling the market that a recession is possible in the next year or so. Munis have not have not inverted in terms of the yield curve because of their tax exemption, but because they're highly correlated, we think that munis are, they are gonna parallel or move in step in lockstep with treasuries, and there's gonna be a flattening of the yield curve. What this means is that short-term munis are gonna outperform long-term munis. And that's what we see for the for the future should there be a recession.
Chip Barnett: (
Okay, we'll be right back after this important message. And we're back talking with Daniel Berger of Refinitiv MMD about the municipal bond market as we enter the second half of 2022.
Gary Siegel: (
So we all know that the yield curve is a predictor of future recessions. Usually if the yield curve, the treasury yield curve goes negative, then a recession is 12 to 18 months away. You said the curve is flattening again. The treasury curve is flattening again. Do you see it turning negative and predicting our recession?
Daniel Berger: (
I'm glad you asked that question. We, we haven't seen, it's been rare to see municipal bonds have a negative yield curve. We've seen that only once or twice, and that's been in the two to three year range in the, in the two to 10 year range because of the tax exemption of muni bonds. We've never seen it. That's not to say it couldn't happen in the future. We've just seen a flattening and, and we we've done work on the correlation of Munis to treasuries. So it's a possibility in the future. But what we have seen is that the correlation between munis and treasuries were way outta whack in 2020 and 2021, and they approaching pre pandemic levels and they're almost at levels of, of 2019 and earlier. And they've approached the correlation is about 90% in two years. And, and out in one year, it's about 85%. So we've seen strong correlations. So it's possible that it could go negative. It's doubtful that it will, that the, that, that part of the slope, the two to 10 year will go ne will go negative. Although flattening is a possibility, just like Powell said that recession is a possibility, certainly flattening is, is, and going negative is also a viable possibility. Although it's doubtful because of the tax exemption of muni bonds,
Gary Siegel: (
If the economy does fall into recession, what does that do to muni bonds going forward?
Daniel Berger: (
There'll still be a demand for tax exempt bonds. And I can't see, and it could be a favorite investment in terms of the asset allocation of investors. Uh, we've seen, uh, muni bonds and we've looked at in terms of holdings of muni bonds. And that might be a question that you'll ask that chip might ask me about holdings of muni bonds. And we've seen, uh, retail investors looking at the fed flows. We've seen it pretty steady where muni bonds have been in terms of households for the first quarter of this year, about slightly more than 40%, whereas they were about, uh, comparably about 43%. What we've seen is mutual funds have picked up the slack, but that these numbers are gonna change as mutual funds have liquidated at a very rapid, uh, pace in the, these numbers are all subject to change. So you, you may see, but nonetheless muni bonds are going to are in terms of asset allocation are gonna be a steady portion of, uh, of investors' holdings. I'm not sure what it means for the stock market, but it, muni bonds will be a safe Haven for our retail investors
Gary Siegel: (
Correct me if I'm wrong, the bond market is now pricing in a 50 basis point rate hike at the next Fed meeting.
Daniel Berger: (
Pretty much it's been baked in the cake. I think yes, the answer is that it has been and if you've seen the spread winding, which I alluded to and, and that's occurred despite, the credit profiles of muni bonds really increasing during the first half of this year where we we've had more upgrades than downgrades.
Chip Barnett: (
Okay Dan, let's get into the weeds. You know over the past couple of years, 2020, 2021 munis yields were down around historical lows, but since start of the year, there's been a tremendous amount of volatility with rates, just going higher and higher. You talked about volatility in the first half. Do you think this is going to continue into the second half?
Daniel Berger: (
There's no reason to think that it wouldn't. Volatility is the name of the game. Volatility, I don't see ending. I see volatility continuing, certainly for the next half of the year. It's almost at its high for the year. And it's possible that it could get higher as we go further out in the year.
Chip Barnett: (
You know, you talked a little bit earlier about municipal bond funds and their flows. For the past couple of years, they've been seeing people investing, putting cash into them. And now since this year, they just like have been having massive outflows. What do you predict for the rest of the year for municipal bond flows?
Daniel Berger: (
Well, municipal bond flows have been negative for the 21 of the first 25 weeks of this year. And you've had outflows of about $45.6 billion, according to Lipper, that's an average outflow of $1.8 billion. And you contrast that to last year where you had inflows and you had steady inflows. And in fact, last year you had outflows in only one of the 52 weeks. Outflows were only one week inflows were for 51 of the 52 weeks. And the inflows averaged about $1.2 billion. So you have a difference of about $3 billion in terms of flow of funds. And that's what we're seeing, but should the fed hesitate or not raise rates as much as predicted you could see muni bonds steadily there's a pent up demand.
Daniel Berger: (
There's gonna be bond redemptions of about $70 billion during the month. And that could really help the July 1st coupon payment in terms of redemptions there's gonna be reinvestment demand, so that could fuel the marketplace and pick up the slack in terms of, there could be a lot of cash chasing after few bonds. So that could bolster the market. So I'm guardedly optimistic for the next couple months that you may see it rally as possible.
Chip Barnett: (
You know, you were talking about who holds muni bonds today. Could you give us a little more detail about that?
Daniel Berger: (
Sure. Inn terms of the Fed, the Federal Reserve puts out numbers, and in terms of the numbers that they put out, households account for about 40% for the first quarter and mutual funds were about 21.8% as contrasted if you go back to even 2018, households were about 47% in mutual funds were about 17%. So really retail investors through mutual funds have increased their mutual fund holdings. But as a percentage of total ownership, they've gone from, it's been about steady — but what what's happened is that households owned own less as directly, but they they've. What they've done is that's increased the volatility a little bit as mutual funds, professional are, are managed by professionals. They may be quicker to liquidate than households, and that may be, be at one factor. That's adding to the volatility of muni bonds,
Gary Siegel: (
Any final thoughts for our listeners today, Dan?
Daniel Berger: (
I guess that there could be as I mentioned a rally of sorts during the next couple months. And it really depends on what happens with the Fed in terms of interest rates. What we've seen is that muni bonds have not performed as well as treasuries during the first half of the year. And we've seen outflows, but should the stock market continue to decline, and this equity market is set to record its its worst performance in 52 years, you could have people invest in muni bonds, which really are the safe haven for a lot of investors. So I'm guardedly optimistic that the next that the next quarter could be could spark a little bit of a rally.
Chip Barnett: (
Daniel Berger of Refinitiv MMD., thank you very much for joining managing editor Gary Siegel and myself today.
Daniel Berger: (
Thank you very much.
Chip Barnett: (
And thank you to the listeners of this latest Bond Buyer podcast, special thanks to Kellie Malone, who did the audio production for this episode. And don't forget to rate us, review us and subscribe at www.bondbuyer.com/subscribe. For the Bond Buyer I'm Chip Barnett. And thank you for listening.