- Despite disappointing municipal market returns for the 2nd quarter 2022, rising rates and negative total returns are leading to markedly improving valuations. Higher nominal yields and wider credit spreads could provide a more stable foundation for municipals going forward.
- In our view, we may be nearing the end of the cycle of rising interest rates, with the current market and economic balance reflective of late-cycle high inflation conditions. What this may mean for investors over the medium term is greater downside risk from credit risk than from interest rate risk.
- We expect continued sentiment shifts as market participants anticipate the turning of the economic and credit cycle. While weighing the potential impact of policy actions remains critical, higher rates, Fed balance sheet reduction, and less expansive fiscal policy could begin to rein in near-term inflationary bias.
- While credit fundamentals remain solid, some sector metrics have declined modestly. Our municipal credit analysts view the Higher Education sector as moderately deteriorating amid declining enrollment due to domestic demographic pressures particularly in the Northeast and Midwest. Smaller schools tend to struggle to attract students and maintain balanced operations while large, wealthy, more selective schools continue to perform admirably.
- Elsewhere across sectors, utilities within the Water/Sewer sector remain in stable financial condition, but water utilities face headwinds in the western US due to ongoing drought conditions. Utilities are forced to rely on expensive imported water from state or regional sources, rather than local sources. These providers have many stakeholders, which means the strength of water rights will become increasingly important to this situation.