To ensure an optimal and secure experience, please upgrade to the latest version of your browser.
Fixed income investment experienced a challenging H1 in 2022, amid increased geopolitical uncertainty, rising interest rates and soaring inflation. Against this backdrop, US municipal mutual fund outflows topped US$86bn during the first half of the year1, reflecting the difficult macro backdrop - led by aggressive Federal Reserve rate hikes - and high inflation data.
Yet in a fixed income universe swirling with uncertainty, Insight Investment head of municipal bonds, Dan Rabasco points to the continued resilience of tax-exempt municipal bonds. “The relatively defensive nature of tax-exempt municipals appears to have held up so far this year. In fact, there are very few global fixed income markets that have done better relative to tax-exempt municipals so far this year.
“To the extent that investors are concerned about interest rate volatility, we believe that return prospects for tax-exempt municipals should be superior over the medium term and in positive contrast to what we experienced in the first half of 2022,” he says.
In contrast, taxable municipal bonds – which attract investment from both US and non-US investors - have performed less well this year but, Rabasco adds, could also offer significant potential. “The yields on longer maturity investment grade taxable munis are the highest they’ve been in eight years and we believe could offer some attractive yield spread pickup to like rated corporates. A consideration for a non-US investor however is the current high cost of currency hedging,” he adds.
While overall recent outflows from municipal bonds remain of some concern, Rabasco believes it is a short-term phenomenon. Historically, he adds, the one-to-two-year time periods following some previous large municipal bond market drawdowns have shown a strong rebound, which may augur well for the market in the months ahead.
“Municipal bond markets can shift quite quickly and tend to bounce back just as fast. Although the current market conditions are far from ideal, we see some positive signals ahead,” he says.
“As we enter the latter half of the year, we believe there are several tailwinds that should support municipal bond performance on the back of a solid fundamental credit backdrop and strong seasonal reinvestment demand as we approach the end of the year.” Also, greater clarity on the macro-economic front, specifically the domestic inflation trend and Fed monetary policy could help temper overall interest rate volatility.
Rabasco believes fundamental credit conditions remain solid overall for many US state and local governments, aided by earlier federal support, waning Covid-19 cases, and favorable tax-revenue trends. “We continue to see opportunities in travel-related credits such as airports and toll roads, which have seen volumes recover to near pre-pandemic highs due to pent-up demand. So-called essential service revenue bonds2 in areas such as electricity supply, water and sewerage and waste disposal also appear to be holding up well,” he adds.
Geographically, some of the more prosperous US states benefited from strong federal government support during the pandemic. According to Rabasco this has helped some states strengthen their balance sheets and address specific shortfalls such as pension fund deficits.
“California, Connecticut, Pennsylvania, and New York State are among those states whose financial health appears to have improved over the past 18 months, though some states are still grappling with issues such as relatively weak pension scheme funding ratios,” he adds.
Rabasco believes the market, which has already shown resilience in the face of the increasingly challenged market, presents ongoing potential for longer term investors.
Looking ahead, beyond the current market volatility Rabasco see the emergence of environmental social and governance (ESG) friendly municipal bonds as a growing, if nascent trend in the US.
“The ‘green’ municipal bond market is still evolving. As far as responsible investment goes there is still little standardization in the US and the definition of what constitutes an ‘ESG bond’ is certainly less clear than it is in Europe, though that should change over time as the market becomes more sophisticated.
“Nevertheless, there is a well of potential in responsibly invested issuance and we are seeing an increase in the issuance of ESG-labelled bonds, notably in the green and social areas. The largest area of growth appears to be in social bonds, with many deals going toward affordable housing projects that aid low-income populations,” he concludes.
1 Source: Insight Investment/ Investment Company Institute, Bloomberg as of June 30, 2022
2 Municipal debt securities designed to finance projects in areas considered “essential”, like utilities.
FOR INSTITUTIONAL, PROFESSIONAL, QUALIFIED INVESTORS AND QUALIFIED CLIENTS. FOR GENERAL PUBLIC DISTRIBUTION IN THE U.S. ONLY.
This material should not be considered as investment advice or a recommendation of any investment manager or account arrangement, and should not serve as a primary basis for investment decisions. Any statements and opinions expressed are as at the date of publication, are subject to change as economic and market conditions dictate, and do not necessarily represent the views of BNY Mellon or any of its affiliates. The information has been provided as a general market commentary only and does not constitute legal, tax, accounting, other professional counsel or investment advice, is not predictive of future performance, and should not be construed as an offer to sell or a solicitation to buy any security or make an offer where otherwise unlawful. The information has been provided without taking into account the investment objective, financial situation or needs of any particular person. BNY Mellon and its affiliates are not responsible for any subsequent investment advice given based on the information supplied. This is not investment research or a research recommendation for regulatory purposes as it does not constitute substantive research or analysis. To the extent that these materials contain statements about future performance, such statements are forward looking and are subject to a number of risks and uncertainties. Information and opinions presented have been obtained or derived from sources which BNY Mellon believed to be reliable, but BNY Mellon makes no representation to its accuracy and completeness. BNY Mellon accepts no liability for loss arising from use of this material.
All investments involve risk including loss of principal.
Not for distribution to, or use by, any person or entity in any jurisdiction or country in which such distribution or use would be contrary to local law or regulation. This information may not be distributed or used for the purpose of offers or solicitations in any jurisdiction or in any circumstances in which such offers or solicitations are unlawful or not authorized, or where there would be, by virtue of such distribution, new or additional registration requirements. Persons into whose possession this information comes are required to inform themselves about and to observe any restrictions that apply to the distribution of this information in their jurisdiction.
This material is only for distribution in those countries and to those recipients listed, subject to the noted conditions and limitations: For Institutional, Professional, Qualified Investors and Qualified Clients. For General Public Distribution in the U.S. Only. • United States: by BNY Mellon Securities Corporation (BNYMSC), 240 Greenwich Street, New York, NY 10286. BNYMSC, a registered broker-dealer and FINRA member, and subsidiary of BNY Mellon, has entered into agreements to offer securities in the U.S. on behalf of certain BNY Mellon Investment Management firms. • Europe (excluding Switzerland): BNY Mellon Fund Management (Luxembourg) S.A., 2-4 Rue EugèneRuppertL-2453 Luxembourg. • UK, Africa and Latin America (ex-Brazil): BNY Mellon Investment Management EMEA Limited, BNY Mellon Centre, 160 Queen Victoria Street, London EC4V 4LA. Registered in England No. 1118580. Authorized and regulated by the Financial Conduct Authority. • South Africa: BNY Mellon Investment Management EMEA Limited is an authorized financial services provider. • Switzerland: BNY Mellon Investments Switzerland GmbH, Bärengasse 29, CH-8001 Zürich, Switzerland. • Middle East: DIFC branch of The Bank of New York Mellon. Regulated by the Dubai Financial Services Authority. • Singapore: BNY Mellon Investment Management Singapore Pte. Limited Co. Reg. 201230427E. Regulated by the Monetary Authority of Singapore. • Hong Kong: BNY Mellon Investment Management Hong Kong Limited. Regulated by the Hong Kong Securities and Futures Commission. • Japan: BNY Mellon Investment Management Japan Limited. BNY Mellon Investment Management Japan Limited is a Financial Instruments Business Operator with license no 406 (Kinsho) at the Commissioner of Kanto Local Finance Bureau and is a Member of the Investment Trusts Association, Japan and Japan Investment Advisers Association and Type II Financial Instruments Firms Association. • Australia: BNY Mellon Investment Management Australia Ltd (ABN 56 102 482 815, AFS License No. 227865). Authorized and regulated by the Australian Securities & Investments Commission. • Brazil: ARX Investimentos Ltda., Av. Borges de Medeiros, 633, 4th floor, Rio de Janeiro, RJ, Brazil, CEP 22430-041. Authorized and regulated by the Brazilian Securities and Exchange Commission (CVM). • Canada: BNY Mellon Asset Management Canada Ltd. is registered in all provinces and territories of Canada as a Portfolio Manager and Exempt Market Dealer, and as a Commodity Trading Manager in Ontario.
BNY MELLON COMPANY INFORMATION
BNY Mellon Investment Management is one of the world’s leading investment management organizations, encompassing BNY Mellon’s affiliated investment management firms and global distribution companies. BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation and may also be used as a generic term to reference the corporation as a whole or its various subsidiaries generally. • Insight Investment - Insight North America LLC (INA) is a registered investment adviser under the Investment Advisers Act of 1940 and regulated by the US Securities and Exchange Commission. INA is part of 'Insight' or 'Insight Investment', the corporate brand for certain asset management companies operated by Insight Investment Management Limited including, among others, Insight Investment Management (Global) Limited (IIMG) and Insight Investment International Limited (IIIL) and Insight Investment Management (Europe) Limited (IIMEL). Insight is a subsidiary of The Bank of New York Mellon Corporation. • Newton Investment Management - Newton” and/or the “Newton Investment Management” brand refers to the following group of affiliated companies: Newton Investment Management Limited (NIM) and Newton Investment Management North America LLC (NIMNA). NIM is incorporated in the United Kingdom (Registered in England no. 1371973) and is authorized and regulated by the Financial Conduct Authority in the conduct of investment business. Both Newton firms are registered with the Securities and Exchange Commission (SEC) in the United States of America as an investment adviser under the Investment Advisers Act of 1940. Newton is a subsidiary of The Bank of New York Mellon Corporation. • Alcentra - The Bank of New York Mellon Corporation holds the majority of The Alcentra Group, which is comprised of the following affiliated companies: Alcentra Ltd. and Alcentra NY, LLC. which are registered with the U.S. Securities & Exchange Commission under the Investment Advisers Act of 1940. Alcentra Ltd is authorized and regulated by the Financial Conduct Authority and regulated by the Securities Exchange Commission. • ARX is the brand used to describe the Brazilian investment capabilities of BNY Mellon ARX Investimentos Ltda. ARX is a subsidiary of BNY Mellon. • Dreyfus is a division of BNY Mellon Investment Adviser, Inc. (BNYMIA) and Mellon Investments Corporation (MIC), each a registered investment adviser and subsidiary of BNY Mellon. Mellon Investments Corporation is composed of two divisions; Mellon, which specializes in index management and Dreyfus which specializes in cash management and short duration strategies. • Walter Scott & Partners Limited (Walter Scott) is an investment management firm authorized and regulated by the Financial Conduct Authority, and a subsidiary of BNY Mellon. • Siguler Guff - BNY Mellon owns a 20% interest in Siguler Guff & Company, LP and certain related entities (including Siguler Guff Advisers LLC).
No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. All information contained herein is proprietary and is protected under copyright law.
NOT FDIC INSURED | NO BANK GUARANTEE | MAY LOSE VALUE |
©2022 THE BANK OF NEW YORK MELLON CORPORATION
GU-293 - 1 September 2023