David Farace, portfolio specialist, and Nick Venditti, senior portfolio manager and head of the Municipal Fixed Income team at Allspring Global Investments, discuss the current state of the municipal market, how we got here, and what opportunities are out there.
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Bryan Piskorowski: Hello, I’m Bryan Piskorowski and you’re listening to On the Trading Desk®.
Today, we’re discussing the current state of the municipal market, how we got here, and what opportunities are out there.
Joining us is Nick Venditti, senior portfolio manager and head of the Municipal Fixed Income team. Also with us is David Farace, portfolio specialist with the Allspring Municipal Fixed Income team. Thanks for being here, Nick. Thanks for joining us, Dave.
Nick Venditti: Thank you so much.
David Farace: Thanks, Pisko. Great to be here.
Bryan: Awesome. Well, look, let’s face it. 2022 has been an interesting year for the bond market and for municipals, in particular. But it’s probably best, I think, to start with some perspective and look further back than just this year-to-date type of performance. Dave, can you give us some detail and color on the bond market and the journey that we’ve been going on since last year?
David: Sure, absolutely. I’d be happy to. In 2021, we saw a contrast when comparing the tax-exempt muni market to its taxable counterparts, including Treasuries. And what I mean by that is while muni yields fell to all-time lows in 2021, the taxable bond and Treasury yields were, in fact, rising and not a lot of people think about that, given the extreme move we’ve seen this year. But the 10-year Treasury bottomed around 50 basis points in August 2020 and has been rising ever since.
So in 2021, why did munis fall to these all-time lows? The answer is fairly simple. It’s demand, right? In 2021, investors, primarily retail investors, poured over $100 billion into muni bonds fueled by fears of potential tax increases and searching for yield, especially in the high-yield market as municipalities were being upgraded after receiving trillions of federal stimulus. So the end result to that is munis finished 2021 at historically high prices, historically low yields, especially when compared to Treasuries.
Now as we know in 2022, that sentiment and the market completely reversed. Inflows turn to outflows in anticipation of the Fed (Federal Reserve) taking steps to curb inflation. All bonds rose in yield as prices cratered and what we have seen in the tax-exempt market is municipal bonds cheapening substantially both on an absolute basis and in relation to their taxable cousins.
So as a bond manager within this environment, we are now today seeing opportunities here in this market that we have not seen in years.
Bryan: So Nick, were investors really reaching back in that 2021 timeframe prior to 2022? And now that we’ve seen overall yields creep up—we’ve seen bond prices go down, there is that inverse relationship—has this been function of lessening credit quality? You can say the market is cheaper now because, obviously, prices are lower, but what’s so compelling about that?
Nick: Yes, to both of those questions, Pisko. Look, the reality is that investors have been in a pretty difficult situation for quite a few years now, right? It’s been very, very difficult to generate any kind of yield across any asset class for portfolios. And by virtue of that, we saw in munis, as well as other fixed income asset classes, investors start to take more and more risk for less and less incremental yield, and ultimately, that’s a bad risk reward trade-off.
Now fast forward to today and munis look cheap. They look cheap on an absolute basis and they look cheap on a relative basis, as well. And they look cheap because we have seen this violent, quick move in Treasury rates.
The good news, though, is that credit fundamentals in the municipal bond market still generally look pretty strong. So fundamentally, the market is sound, and now that perhaps some of these larger macro events are behind us, or at least the bulk of them are behind us, it’s starting to look like a pretty good entry point for investors in the municipal bond market.
Bryan: So where are you guys all seeing the opportunities? What looks best? What looks most attractive? Where do you think we can capitalize on being able to build better income portfolios for clients today?
Nick: Sure. Look, I think that’s that the $32,000 question, right? And ultimately, we are in a scenario where absolute rates are significantly higher. I would throw just a couple of notes of caution out there to potential investors in that we have seen credit spreads in munis and other fixed income asset classes start to widen, but there’s probably a little bit more room for credit spread widening, in spite of, again, the fact that fundamental credit quality looks pretty strong.
Similarly, on the duration side, although we have seen a marked move in absolute yields, we’re still living in a world where yield curves, namely the Treasury curve, is incredibly flat. In fact, it’s more than just flat. It’s significantly inverted, out long. And so by virtue of that, we aren’t overly excited about taking on significant duration risk in here.
Think about it kind of simply, right? If the curve is inverted, that’s weird. That’s not supposed to happen, and we could talk about all the reasons why it might and what it might portend, but ultimately, it’s weird. And so at some point, we know it’s going to get back to normal and it will get back to normal in one of two ways.
Either long rates will come up, in which case you don’t want to own long bonds, or short rates will come down, in which case you don’t want to own long bonds. So while overall I’m pretty bullish on munis from today onward. I do think I’m bullish within the context of investors still need to take both duration and credit risk prudently in this market.
Bryan: So what is it structurally around the muni market that gets you excited?
Nick: Absolutely. Look, we have moved significantly in interest rates already, and it is my humble opinion that we probably moved too far too fast.
The Fed is going to be unable to raise rates as many times as economists have been predicting over the last four, five, or six weeks. Whatever number you have in your head for future rate increases, I’ll take the under, right? If you think 8, I’ll say under. If you say 6, I will say under, and I’ll say that because the Fed has moved rates one, now two times as of yesterday [5-4-2022], and we’ve already shot mortgage rates above 5%. We have already seen used car prices turn over. We’re seeing consumer confidence numbers that look like they did two days after Bear Stearns went belly up in the Great Financial Crisis. After a single interest rate rise, we’ve already seen a marked slowdown in some macroeconomic numbers.
So ultimately, I don’t think the Fed has as much firepower to slow down the economy as some have predicted.
On the credit side, muni issuers benefited significantly from all of the stimulus that was dumped in the economy over the last couple of years. The state of Illinois, as a bellwether for high-profile muni names, was upgraded for the first time in 25 years. Munis generally look pretty strong from a credit perspective and if the bulk of the rate move is behind us, then I think this is a great entry point for investors.
Bryan: Let’s face it, too. I think for advisors and for investors, this is a year where correlations have gotten a lot tighter. Equities and bonds are down on a year-to-date basis and that’s not something investors have seen in quite some time. Navigating at this point going forward, Dave, Nick, what are some things that your team does that, I think in some cases, an individual investor can’t do on his or her own?
David: Pisko, this is David. I would say we know, on the investment management side, that we are at this great entry point and we know that this is a time that is very challenging for a client to step into a market that just saw its largest drawdown in over 40 years. So with that, I think a point of this conversation can be what are we doing as a team in active management?
Munis are an incredibly inefficient market, and they’re one of the few markets left where you can really make a case that active management works, and it works well because of the inefficiencies out there. And I think we as a whole do a very, very good job of offering a wide range of solutions to these clients who, obviously, have different risk profiles and different time horizons.
Whether we are offering them something in the mutual fund space or the separate account space or whether we have a solution for them across a muni bond ladder, I think it’s important that we do a good job conveying that we are bringing these years of experience and this team and this really broad, diverse group and deep credit research to the table.
Bryan: Perfect. Well, thank you, gentlemen. Thanks for joining us here today. And that wraps up this episode of On the Trading Desk. If you’d like to read more market insights and investment perspectives from Allspring Global Investments, you can find them at our firm’s website, allspringglobal.com.
To stay connected to On the Trading Desk and listen to past, as well as future episodes of the program, you can subscribe to the podcast on Apple Podcasts, Spotify, or wherever you get your podcasts. Until next time, I’m Bryan Piskorowski and thanks for listening.
Disclosure: All investing involves risk, including the possible loss of principal. There can be no assurance that any investment strategy will be successful. Investments fluctuate with changes in market and economic conditions and in different environments due to numerous factors, some of which may be unpredictable. Each asset class has its own risk and return characteristics.
100 basis points equals 1.00%.