Bond market forecast for second half of 2021
The municipal bond market took a wild ride in the first half of the year to near-historic levels of richness versus Treasuries that is rarely seen, and the environment is ripe for the second half of the year to take it even further. The outperformance of municipals in the first half can be attributed to many factors, such as inflation, rising tax rates and an imbalance of supply and demand. I believe these factors will continue in the second half setting up another favorable period for the municipal bond market.
According to Bloomberg market data, municipal bond yields have traded at approximately 100% of Treasury yields for the last two decades with two notable exceptions in late 2008 to early 2009 and then again in 2020, when long-term municipal bond yields traded significantly higher than long term treasury yields. The first half of 2021 saw municipal yields fall from approximately 90% of treasuries to 70% of treasuries which lead to municipal bonds outperforming treasuries by approximately 400 basis points. The Barclays U.S. Treasury index returned -3.44% versus Barclays municipal bond index return of 0.65%.
The main factor in the second half of the year that should help municipal performance is that the market is starved for supply. Demand has far outstripped supply so far this year, and I expect that to continue. Cash inflows into municipal bonds has been approximately $50 Billion in the first half with approximately $350 Billion in bonds being called or maturing. According to Ramirez and Co., the $350 billion being called or maturing is more than the expected total tax-exempt issuance for the year of $331 Billion. Add in a very strong interest payment season during June, July, and August and I find it very difficult for the municipal bond market not to do well in the second half of the year.
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