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The incremental reopening of the economy and improving labor market conditions contributed positively to equity market performance in July, however the path of recovery remains uncertain and highly dependent on the course of the virus.
As the economy gradually reopens, state and local governments may see improvement in tax collections as workers continue to return to their jobs. The Bureau of Labor Statistics released its latest report on the state of the labor market on August 7. The unemployment rate declined to 10.2% in July, adding 1.8 million jobs to the economy. However, concerns of a second wave, coupled with a resurgence in infections in states such as Texas, Florida, Arizona, and California, may slow the pace of re-openings. As phase 4 stimulus negotiations continue, many municipal market participants have turned their attention to Washington. Investors are particularly interested in the potential state and local government aid that could be included in the next package. Sector-specific aid, such as education, transportation, and healthcare will be closely monitored as well.
Municipal market performance was mixed for the month of July. The Bloomberg Barclays Municipal Index returned 1.68 percent for the month, marking the third consecutive month of positive returns. Higher yielding credits outperformed investment grade by 103 basis points, returning 2.72 percent for the month. This marks the third consecutive month of high-yield outperformance versus investment grade peers. Investment grade credits were led by lower quality, Baa-rated bonds, which returned 3.31 percent in July. The highest-grade, AAA-rated bonds ended the month 1.40 percent higher.
Investors searching for yield have found themselves purchasing longer-dated bonds. This is reflected in the outperformance of the longer maturity portion of the index. Over the past month, municipal bonds in the one to five-year maturity range returned a positive 0.72 percent. Intermediate municipals with five to ten-year maturities returned a positive 1.58 percent, while long-dated bonds with maturities greater than 22 years posted a positive 2.36 percent.
On the supply side, taxable municipal issuance continues to surge, driving this year’s new issue supply volume. This elevated supply is being driven by advanced refundings, leading year-to-date taxable issuance to make up 29 percent of the total municipal supply. Historically, taxable issuance has only made up 5 to 10 percent of total supply.
Demand remains strong with municipal funds posting their 12 week of consecutive inflows. Net mutual fund flows are now positive for the year, coming a long way from their lows of near 26 billion in net outflows. This trend of strong demand may continue considering the favorable muni-Treasury ratios. The 10-year muni to Treasury ratio ended the month at 121 percent compared to its three-year average level of 93 percent. Relative attractiveness of municipal yields may keep pressure on demand in this lower-for-longer environment. On July 29, the Federal Reserve left its benchmark lending rate unchanged near zero as Fed chair Jerome H. Powell predicted a long recovery ahead.