Municipal bonds have been favorable among investors in 2021 for a few reasons, including competitive yield relative to other areas of the global fixed income market, new issuance, and pending infrastructure spending plans in DC. In fact, municipal bond funds continued to gather assets this summer, posting net inflows of $10.6B in July, bringing the year-to-date total to $61.7B.1

To get a closer look at the dynamics of the muni marketplace as we move into the back half of 2021, Loomis, Sayles & Company’s Municipal Bond Team member and Investment Strategist Jim Grabovac offers insight.

What do muni market fundamentals look like at this phase of the recovery?

Since the American Recovery Plan’s passage, the underlying credit fundamentals in the municipal market have improved sharply across most major sectors amid a strong economic recovery. Like other fixed income asset classes, munis have benefited from the sizable amount of liquidity that policymakers have injected into the system – suppressing rates, tightening spreads, and buoying markets. Market participants appear focused on the prospects for infrastructure legislation. The municipal market, perhaps more than any other sector, could be significantly impacted by whether legislation makes it past upcoming hurdles.

We have already seen an accelerated pace of new issue volume in municipal bonds this year. We think this will certainly be impacted by the outcome of President Biden’s infrastructure bill.

So, an infrastructure deal could mean lots of new issuance?

We anticipate a significant increase in the issuance of taxable municipals if, and when, legislation passes, as direct subsidy bonds appear to be a likely financing option. The bipartisan framework would add $579B of infrastructure spending (over 8 years), largely targeting traditional areas of infrastructure investment affecting transportation, bridges, water, clean power, and broadband access. Whether this framework can pass a finely balanced Congress remains an open question.

Has the Delta variant impacted your team’s views on any sectors?

Our municipal credit analysts are carefully watching developments from the economic fallout from Covid-19 and assessing the potential impact. Due to continued positive developments through rapidly increasing dissemination of vaccines and expectations for strong economic growth, we envision a positive outlook for the convention/business travel sector. In fact, our outlook recently improved from stable to positive. Many anecdotes point to an accelerating pickup for the remainder of 2021.

Despite likely pent-up demand for business travel, that sector’s rebound could be softened by fundamental behavioral changes related to travel and large crowds. The convention center debt backed by general sales or governmental support has recovered at a faster pace than those names that rely on volumes of convention/business travel activity. Furthermore, our positive outlook reflects the expectation that the credit quality of names within this sector will generally be improved a year from now.

With Democratic control of the White House and Congress, do you see related impacts for any particular municipal bond sectors?

We envision increased regulation in the public power sector. Fuel mix will likely be a determinant of the impact regulations have on issuers. This could certainly have a negative impact for coal, as it has been priced out of the market for years due to low cost natural gas from fracking and the declining cost of renewables. In fact, increased federal regulation could accelerate coal’s demise. We view natural gas and nuclear resources as neutral. We view utilities that are proactive in transition towards renewable energy as neutral to positive. Further tax credits for renewable projects have the potential to spur development.

How might Biden’s focus on climate risk impact the muni market?

The enforcement of carbon reduction standards will vary on a state-to-state basis unless there is significant federal regulation. For now, 29 states have already implemented their own renewable portfolio standards. Low natural gas prices continue to provide a low cost alternative for base load power generation. The progress of utilities in states with aggressive renewable portfolio standards will continue to be monitored in efforts to ensure both compliance and financial effects of the transition.

Would you consider an active management approach to munis to be particularly timely right now?

Despite the improving economy and ongoing recovery and reopening following Covid-19, we think active management is important possibly now more than ever. Our bottom-up security selection driven by credit research is designed to find undervalued issues and avoid those that may be overvalued or poised for downgrade. While we suggest an active approach for most market environments, we think its flexibility is especially important while unknowns related to inflation, infrastructure, and behavioral changes related to Covid-19 could impact credits in unanticipated ways.
1 Strategic Insights Simfund. Includes open-ended long-term mutual funds. Excludes closed-end funds, ETFs, money market funds, and funds of funds.

This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted, and actual results may vary.

All investing involves risk, including the risk of loss. There is no assurance that any investment will meet its performance objectives or that losses will be avoided. Past performance is no guarantee of future results.

Fixed income securities may carry one or more of the following risks: credit, interest rate (as interest rates rise bond prices usually fall), inflation and liquidity.

Municipal markets may be volatile and can be significantly affected by adverse tax, legislative or political changes and the financial condition of the issuers of municipal securities.

Unlike passive investments, there are no indexes that an active investment attempts to track or replicate. Thus, the ability of an active investment to achieve its objectives will depend on the effectiveness of the investment manager.

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