American municipal bonds are yielding less than they have in generations and a key measure shows that valuations are at an all-time high, which would seem to give investors little room to keep piling in.
But they are. Every week since early November, investors have added an average of $2.3 billion to mutual funds focused on state and local government bonds, more than four times the typical amount over the past decade, according to the Investment Company Institute. They’ve also plowed into exchange-traded funds, which
in January raked in the most on record.
That influx -- combined with a seasonal slowdown in new bond deals -- has persisted even as some money managers lament how out-of-whack prices have become and how difficult it is to find valuable places to park their cash.
One reason may be the “feedback loops” that Barclays Plc identified in 2018 as a driver of flows in and out of the municipal market: the individuals who are the biggest investors tend to act in concert, either continuing to send in their cash or pull it out in waves.
That dynamic was in play in March, when waves of panicked selling sent the market into its biggest free fall since at least 1980. But when Congress enacted its first economic stimulus bill and the Federal Reserve moved in to ensure that another liquidity crisis wouldn’t break out, prices rallied back and investors rushed in again.
So far in 2021, the strong demand has helped state and local debt eke out a positive return while Treasuries and corporate bonds have posted losses, according to Bloomberg Barclays indexes.
The Democratic sweep in Washington may also be playing a role, with the next economic stimulus bill promising to send aid to states and cities to close budget shortfalls caused by the pandemic. And any move later to raise taxes on the highest earners would only increase demand for the tax-free income that municipal bonds provide.
BlackRock Inc. said in a note that it expects demand for state and local government debt to stay strong, especially as there’s clarity around President Joe Biden’s tax policy plans. Jim Noble, a portfolio manager for Principal Global Investors, said the source of the steady demand can be traced to a confluence of things, including growing confidence in fiscal aid coming to states and municipalities. The tax shelter also plays a role, he said. “You never hear anybody saying, ‘I think taxes are going to go down,’” he said.
By Amanda Albright
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