Municipal Bonds: Potential Tailwinds in the 2021 Second Half | Lord Abbett
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Market View

We think municipal bond issuers are prepared to take advantage of a U.S. economic reopening.

Read time: 2 minutes

In a new report, “2021 Midyear Investment Outlook,” we encapsulate the views of a panel of Lord Abbett investment leaders on prospects for economies and markets in the second half of 2021. In this commentary, adapted in part from the report, Daniel Solender, Partner and Director of Tax-Free Fixed Income for Lord Abbett, focuses on how municipal bond issuers effectively navigated the COVID-19 pandemic--and their positioning for the transition to a U.S. economic reopening. We urge you to read the full report (available here) or view a replay of a related webinar (registration required).

Positive Forces at Play

Strong growth prospects following a partial economic shutdown a little more than a year ago are a very positive development for the municipal bond market, though investors need to keep an eye on recent inflation concerns. We believe the muni market is well positioned as the U.S. economic reopening unfolds, and there are a number of positive forces at play that contribute to our constructive view.

Sectors severely impacted by the pandemic-led economic shutdown, such as airports, universities, and transportation systems, experienced only small negative moves in credit quality over the past year. We think a reopening will allow these sectors to revert toward more normal usage and revenue levels, and the historically high credit quality of the broad municipal bond market (based on Moody’s data) stands to benefit from accelerating economic growth.

Technical factors continue to be supportive, in our view. Mutual-fund demand for municipal bonds has remained robust, with net inflows posted every week except one in 2021 through May. Nearly $60 billion of combined inflows--across the high yield, investment-grade, and long-, intermediate-, and short-maturity segments—has been invested in municipal bond funds in the first half of 2021, which is the fastest pace for the first half of any year according to Lipper (see Figure 1). On the supply side, issuance has been average overall while being slightly lower in healthcare, education, and state and local governments, while the transportation, utility, and housing sectors have slightly surpassed last year’s pace.

 

Figure 1. After Early 2020 Volatility, Muni Bond Fund Flows Have Strengthened
Weekly municipal bond fund flows, March 31, 2013–June 30, 2021
Source: Lipper. Data as of 06/30/2021. The historical data are for illustrative purposes only, do not represent any specific portfolio managed by Lord Abbett or any particular investment, and are not intended to predict or depict future results.

 

The Biden Administration’s proposed changes to personal and corporate U.S. tax rates could further enhance demand, lending additional appeal to our outlook going forward if they get approved while demand is already strong at current tax rates, even if they don’t rise.

A Final Word

Municipal bonds proved to be very resilient during the pandemic. Overall credit quality was mostly maintained, as issuers adapted to the challenges and had prepared themselves well for potential downturns. Also, substantial Federal government fiscal stimulus across a broad range of muni sectors was quickly and effectively dispersed. Looking forward, we believe a reopening will raise revenue and usage levels, potentially further strengthening the financial standing of municipal bond issuers, while attractive technical dynamics and potential changes to U.S. tax rates provide additional supportive elements.

 

A Note about Risk: The value of an investment in fixed-income securities will change as interest rates fluctuate and in response to market movements. As interest rates fall, the prices of debt securities tend to rise. As rates rise, prices tend to fall. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The municipal bond market may be impacted by unfavorable legislative or political developments and adverse changes in the financial conditions of state and municipal issuers or the federal government in case it provides financial support to the municipality. Income from the municipal bonds held could be declared taxable because of changes in tax laws. Certain sectors of the municipal bond market have special risks that can affect them more significantly than the market as a whole. Because many municipal instruments are issued to finance similar projects, conditions in these industries can significantly affect an investment. Income from municipal bonds may be subject to the alternative minimum tax. Federal, state and local taxes may apply. Investments in Puerto Rico and other U.S. territories, commonwealths, and possessions may be affected by local, state, and regional factors. These may include, for example, economic or political developments, erosion of the tax base, and the possibility of credit problems.

Statements concerning financial market trends are based on current market conditions, which will fluctuate. All investments involve risks, including the loss of principal invested.

This material is provided for general and educational purposes only. The examples provided are for illustra­tive purposes only and are not indicative of any investor situation.

This commentary may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

The credit quality of the securities in a portfolio is assigned by a nationally recognized statistical rating organization (NRSRO), such as Standard & Poor's, Moody's, or Fitch, as an indication of an issuer's creditworthiness. Ratings range from ‘AAA’ (highest) to ‘D’ (lowest). Bonds rated ‘BBB’ or above are considered investment grade. Credit ratings ‘BB’ and below are lower-rated securities (junk bonds). High-yielding, non-investment-grade bonds (junk bonds) involve higher risks than investment-grade bonds. Adverse conditions may affect the issuer's ability to pay interest and principal on these securities.

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education. No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein. If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

The opinions in this commentary are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

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