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Municipal Monthly

December Municipal Market Update: Munis Cap 2023 With Big Rally; Fundamentals Remain Strong

Municipals ended the year with their strongest two-month performance since 1986; yields remain attractive.

Municipal bond performance in focus: Exploring the end-of-year rally and municipal landscape entering 2024

At the end of October, the Bloomberg Municipal Bond Index was down 2.22% year-to-date. Over the two months that followed, the asset class rallied by an impressive 8.82%, propelling the index to a 6.40% gain for 2023. This substantial turnaround resulted in the index’s strongest two-month performance since 1986.  Meanwhile, Bloomberg’s High Yield Municipal Bond Index returned 9.21% over the calendar year, and the Bloomberg Taxable Municipal Bond Index gained 8.84%. For comparison, the Bloomberg U.S. Treasury Index advanced by 4.05% for the year.

Even as municipal bonds have rallied, we believe yields within the asset class remain attractive. Entering the new year, the Bloomberg Municipal Bond Index offered a 3.22% yield to worst, a figure which is more than 90 basis points (bps) higher than the index’s 10-year average.  For individual investors subject to the highest federal income tax bracket, this figure translates to a taxable-equivalent yield of 5.43%.

In 2024, we believe that market technicals – which have presented headwinds for much of the past two years – may turn supportive and could ultimately serve as a performance driver. Municipal bond mutual fund and ETF flows finished 2023 in net negative territory for the second consecutive year; however, flows did turn positive toward the end of December. Should investor sentiment continue to strengthen and result in a sustained period of inflows, municipals would be positioned strongly.

Finally, as we discussed in our previous update, we believe municipal credit fundamentals remain exceptionally strong. The median state rainy day fund currently sits at 12% of expenditures versus a median of 4% from 2000 to 2018. Additionally, many local governments are sitting on historically high levels of reserves, which are augmented by remaining federal aid funds that will be spent down through 2026. In summary, we believe municipals are very well positioned as we enter 2024.

Figure 1 shows two bar charts side by side. The chart at the left shows returns for December and for all of 2023 for the Bloomberg Municipal Bond Index, the Bloomberg High Yield Municipal Bond Index, the Taxable Municipal Bond Index, and the U.S. Treasury Index. Gains in December helped propel each index higher. The Bloomberg Municipal Bond Index gained 6.40% in 2023. The Bloomberg High Yield Municipal Bond Index returned 9.21% over the calendar year, and the Bloomberg Taxable Municipal Bond Index gained 8.84%. For comparison, the Bloomberg U.S. Treasury Index advanced by 4.05%. The chart at the right shows the yield to worst and taxable-equivalent yield to worst for the Bloomberg Municipal Bond Index at the end of 2023 and on average over the past 10 years. Entering the new year, the Bloomberg Municipal Bond Index offered a 3.22% yield to worst, more than 90 basis points higher than the index’s 10-year average. The source for the data is Bloomberg as of 29 December 2023. Taxable-equivalent yield assumes 37% federal income tax and 3.8% Medicare investment tax. 

Month in review

  • The Fed left interest rates unchanged for the third straight time. Given that inflation has declined more rapidly than policymakers had anticipated, the central bank has now turned its attention to rate cuts and is currently projecting three 25-bp cuts in 2024.
  • Both municipal and Treasury yields declined across the curve, while municipal/Treasury ratios richened except at the 30-year tenor. The 10-year AAA MMD yield fell -35 bps to close the month at 2.28%, while the 10-year Treasury yield closed down -48 bps at 3.86%.
  • December’s rate movements drove solid returns for fixed income: The Bloomberg Municipal Bond Index gained 2.32% (6.40% YTD) and the Bloomberg U.S. Treasury Index advanced by 3.36% (4.05% YTD). Meanwhile, Bloomberg’s High Yield Municipal Bond and Taxable Municipal Bond indices increased by 3.00% (9.21% YTD) and 4.96% (8.84% YTD), respectively.
  • New issuance in December totaled $24 billion, down $13 billion from November but exceeding December 2022’s figure of $22 billion.
  • Municipal bond mutual fund and ETF flows turned positive toward the end of December. However, fund and ETF flows finished 2023 in net negative territory for the second consecutive year.
  • The January effect, a municipal market phenomenon in which asset prices tend to appreciate due to seasonal supply/demand imbalances, may propel municipals to additional gains in the coming month. Over the past 15 years, municipals have experienced positive returns an impressive 12 times during January. However, last month’s lighter-than-average December sales calendar and lower rates relative to just a few months ago may lead to increased issuance this month, which could have a dampening effect on the phenomenon.
The Market Snapshot consists of a group of tables and charts. The first, a group of three tables, shows AAA Municipal Market Data (MMD) yields, U.S. Treasury yields, and taxable-equivalent municipal yields as of December month-end, specifically at the two-year, five-year, 10-year and 30-year tenors of each curve. The table shows that AAA MMD yields fell across the curve, declining by as much as 35 basis points in December, while the Treasury yield curve decreased as much as 52 basis points. Taxable-equivalent yields on AAA municipal bonds ranged from 3.85% both at the 5-year and 10-year tenors, to 5.78% at the 30-year tenor in December. Taxable-equivalent yield assumes 37% federal income tax and 3.8% Medicare investment tax. Other tables contain data on municipal index returns, monthly new issuance, and long-term municipal mutual fund net flows. In addition, a chart shows municipal and Treasury yields and the municipal/Treasury ratio at the 2-year, 5-year, 10-year, and 30-year tenors. Data is sourced from Bloomberg, The Bond Buyer, PIMCO analysis of Bloomberg data, Thomson Reuters, and Investment Company Institute, all as of 29 December 2023 except for muni fund flows, which are as of 20 December 2023.  

1 Bloomberg, 29 Dec 2023

2 Ibid

3Ibid

4 Investment Company Institute, Long-Term Mutual Fund and Exchange-Traded Fund (ETF) Flows, 20 Dec 2023

5 NASBO, Fiscal Survey of States, Fall 2023

6 Nick Timiraos, “Fed Begins Pivot Toward Lowering Rates as Inflation Declines,” Wall Street Journal, 13 Dec 2023

7 Thomson Reuters TM3 MMD Interactive Data, 29 Dec 2023

8 Bloomberg, 29 Dec 2023

9 The Bond Buyer: Primary Market Statistics – A Decade of Bond Finance, 29 Dec 2023; Bloomberg Corporate Issued Municipals Data, 29 Dec 2023

10 Investment Company Institute, Long-Term Mutual Fund and Exchange-Traded Fund (ETF) Flows, 20 Dec 2023

11 Bloomberg, 29 Dec 2023

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Disclosures

Past performance is not a guarantee or a reliable indicator of future results.

Investing in municipal bonds involves the risks of investing in debt securities generally and certain other risks. Investors will, at times, incur a tax liability. Income from municipal bonds is exempt from federal income tax and may be subject to state and local taxes and at times the alternative minimum tax. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increases this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed.

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Charts are provided for illustrative purposes and are not indicative of the past or future performance of any PIMCO product.

Bloomberg Municipal Bond Index consists of a broad selection of investment-grade general obligation and revenue bonds of maturities ranging from one year to 30 years. It is an unmanaged index representative of the tax-exempt bond market. The index is made up of all investment grade municipal bonds issued after 12/31/90 having a remaining maturity of at least one year. The Bloomberg High Yield Municipal Bond Index measures the non-investment grade and non-rated U.S. tax-exempt bond market. It is an unmanaged index made up of dollar-denominated, fixed-rate municipal securities that are rated Ba1/BB+/BB+ or below or non-rated and that meet specified maturity, liquidity, and quality requirements. The Bloomberg Taxable Municipal Index represents a rules-based, market-value weighted index engineered for the long-term taxable bond market. For inclusion in the Index, bonds must be rated investment grade quality or better, have at least one year to maturity, have a coupon that is fixed rate, have an outstanding par value of at least $7 million, and be issued as part of a transaction of at least $75 million. The Intermediate Municipal subsector groups together securities with an average maturity between one to 10 years. The Bloomberg 1-10 Year Municipal Bond Index is an unmanaged index considered to be generally representative of investment-grade municipal issues having remaining maturities from 1-10 years and a national scope. The Bloomberg Muni Short (1-5) Index is the Muni Short (1-5) component of the Bloomberg Municipal Bond Index. The Bloomberg U.S. Treasury Index is a measure of the public obligations of the U.S. Treasury. Bloomberg U.S. Aggregate Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. These major sectors are subdivided into more specific indices that are calculated and reported on a regular basis.  It is not possible to invest directly in an unmanaged index.

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