FMNY - Thoughts From The Municipal Bond Desk (June Edition)

2023-06-30 09:45:00 ET

Summary

• The municipal market has been able to post positive performance thus far in 2023 despite negative net mutual fund flows.
• Negative fund flows have been manageable as issuance has remained muted, and flows are expected to turn as funds from coupons and maturing bonds reenter the market.
• Elevated inflation has hampered the profitability of not-for-profit health care systems. We believe bottom-up fundamental credit research will be the key to investing in the sector going forward.

By Mark Paris, Chief Investment Officer, Head of Municipal Strategies, Invesco Fixed Income; and Stephanie Larosiliere, Head of Municipal Business Strategies and Development

We ask and answer key questions and highlight munis by the numbers providing a quick look at some commonly used muni market datapoints. Here’s our insight for June.

Stephanie: Amid heightened macro volatility, municipals have been able to produce positive returns on a year-to-date basis. High yield munis are up over 3.5%, investment grade is up over 2% and taxable munis are up over 4%. ¹ Has this triggered a positive feedback loop in mutual fund flows?

Mark: Not yet. For the week ending June 7, 2023, combined weekly and monthly outflows YTD are roughly $8.5 billion. ² While that sounds like a very large number, the municipal market has easily digested the outflows this year, and that number is quite small compared to the $121 billion in outflows the market experienced in 2022. ² Meanwhile, primary market issuance remains muted. In May alone, issuance was down 29% compared with May 2022, due primarily to higher interest rates, concerns over the debt ceiling debate, Federal Reserve policy moving forward and overall muni market volatility. Interestingly, Texas has increased debt issuance YTD by 15.4% and is the largest state issuer so far in 2023. California and New York, the next two largest issuers YTD, are down 6.6% and 47.6% respectively. ³

Stephanie: Are you expecting this pattern to persist through the summer months?

Mark: We don’t expect it to persist. There should be a bit of respite once demand driven by reinvestment from called and maturing bonds accelerates. Historically, investment-grade municipals have generated a positive total return for the month of July in every year since 2013, even during times of investment outflows. ¹

Stephanie: On the credit side of things, I’d like to spend some time on the hospital sector, more specifically, not-for-profit health care systems, which make up about 7% of the muni market. ⁴ The sector has been in the headlines recently related to the pressures it has faced during what has been one of the most notable periods of US inflation. What are your thoughts on the sector?

Mark: All industries have felt the sting from this current inflationary period, but hospitals have been facing unique pressures. Labor and supply expenses are growing, while hospital margins continue to decline. The average hospital operating margin was negative in 2022 and declined by 20% from the prior year. ⁵ The knock-on effect is that unstable revenue streams can lead to credit rating downgrades. The best way to navigate the sector is pay close attention to the idiosyncratic risks. Our team of 24 analysts conducts bottom-up fundamental research on every bond that goes into a portfolio, putting an Invesco proprietary rating on the credit. This process has allowed us to focus our portfolios on hospitals where staffing shortages are more manageable and where we have seen financial improvement as patient admissions and emergency department visits have increased.

Munis by the numbers

A quick look at some commonly used municipal market datapoints.

Fund flows: Weekly and monthly reporters in $ millions

Week ending June 7, 2023

Source: Lipper US Fund Flows, JP Morgan, as of June 7, 2023. YTD = year to date.

30-day visible supply (billions)

The 30-day visible supply is compiled daily from The Bond Buyer's Competitive and Negotiated Bond and Note Offerings calendars. It reflects the dollar volume of bonds expected to reach the market in the next 30 days. Issues maturing in 13 months or more are included. From January 6, 2023-June 9,2023.

One-month yield change: 4/28/23 - 5/31/23 (percent change)

UST = United States Treasury. A credit rating is an assessment provided by a nationally recognized statistical rating organization (NRSRO) of the creditworthiness of an issuer with respect to debt obligations, including specific securities, money market instruments or other debts. Ratings are measured on a scale that generally ranges from AAA (highest) to D (lowest); ratings are subject to change without notice. For more information on rating methodologies, please visit the following NRSRO websites: www.standardandpoors.com and select ‘Understanding Ratings’ under Rating Resources on the homepage; www.moodys.com and select ‘Rating Methodologies’ under Research and Ratings on the homepage.

Municipal/Treasury ratio

Treasuries are backed by the full faith and credit of the US government as to the timely payment of principal and interest, while legislative or economic conditions could affect a municipal securities issuer's ability to make payments of principal or interest.

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Footnotes

¹ Source: Bloomberg Barclays as of June 14, 2023.

² Source: Lipper US Fund Flows, JP Morgan, as of June 7, 2023.

³ Source: BondBuyer

⁴ Source: Bloomberg

⁵ Source: Deloitte Institute, November 2022

Important information

Header image: The Good Brigade / Getty

NA 2968742

Municipal securities are subject to the risk that legislative or economic conditions could affect an issuer’s ability to make payments of principal and/or interest.

Junk bonds involve greater risk of default or price changes due to changes in the issuer’s credit quality.

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested. The values of junk bonds fluctuate more than those of high-quality bonds and can decline significantly over short time periods.

All fixed income securities are subject to two types of risk: credit risk and interest rate risk. Credit risk refers to the possibility that the issuer of a security will be unable to make interest payments and/ or repay the principal on its debt. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa.

Municipal bonds are issued by state and local government agencies to finance public projects and services. They typically pay interest that is a tax in their state of issuance. Because of their tax benefits, municipal bonds usually offer lower pretax yields than similar taxable bonds.

All data as of June 15, 2023 , unless otherwise stated.

All data provided by Invesco unless otherwise noted.

The opinions expressed are those of the author, are based on current market onditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. It is not intended or written to be used, and it cannot be used by any taxpayer, for the purpose of avoiding tax penalties that may be imposed on the taxpayer under US federal tax laws. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation.

This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions.

Past performance does not guarantee future results. An investment cannot be made into an index.

Forward looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions, there can be no assurance that actual results will not differ materially from expectations.

There is no guarantee the outlooks mentioned will come to pass.

High yield munis are represented by the Bloomberg Municipal High Yield Bond Index. The Bloomberg Municipal High Yield Bond Index s generally representative of bonds that are non-investment grade, unrated or rated below Ba1.

Investment grade munis are represented by the Bloomberg Municipal Bond Index. The Bloomberg Municipal Bond Index is an unmanaged index considered representative of the tax-exempt bond market. An investment cannot be made into an index.

Taxable munis are represented by the Bloomberg Taxable Municipal Index. The Bloomberg Taxable Municipal Index measures the US municipal tax ab le investment grade bond market.

©2023 Invesco Ltd. All rights reserved

Thoughts from the municipal bond desk (June edition) by Invesco US

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