In March, munis benefited from the flight to quality seen in US Treasury securities, reflecting bank solvency fears. Tax-exempt paper rallied by over 2%, reversing most of February's losses. For 1Q 2023, munis have gained 2.7% on a total return basis. In the early part of the 2Q, we anticipate market participants to shift their focus back to inflation and the prospect for further Fed reserve rate hikes.
Issuance remained light reflecting volatility
In March, the volume of new municipal bond sales (USD 31.8bn) declined by 30% compared with the same time last year (USD 45.5bn). And, for the first three months of 2023, total issuance (USD 75.5bn) is down by 27% on a year-over-year basis. We attribute the lighter supply in March in part to the surge in market volatility reflecting bank solvency fears. That said, the 30-day visible supply has now increased to reach USD 10.7bn, up from only USD 5.4bn in mid-March.
Consider cross-asset barbell opportunities
We believe positioning assets in short-dated bonds (for liquidity and reinvestment opportunities) along with an allocation to munis with longer maturities beyond the 10-year spot with high coupons (for incremental income) is prudent. At present, high grade munis provide the most attractive tax advantages at the 12-year maturity point and beyond. By contrast, the value at the front part of the curve is mixed. At the 1-year to 5-year spots, taxable corporate debt may offer better value even after adjusting for taxes.
Credit spreads held steady
In 1Q 2023, credit quality spreads remained relatively stable. As a point of reference, over the past three months, spreads on AA munis and single-A munis both narrowed by only 2bps to now sit at 36bps and 16bps, respectively. At the same time, spreads on lower-rated BBB munis held at 90bps throughout 1Q. That said, we believe that now is a good time to diversify and consider upgrading the quality of muni portfolios for resilience through an economic downturn.
Read the original blog Muni 1Q 2023 performance update (3 April 2023), which includes charts that visualize its key points.
Main contributor: Kathleen McNamara
This content is a product of the UBS Chief Investment Office.
Look for the next edition of the “Municipal Market Guide” on 13 April 2023.