Municipal bond market update: A pleasant surprise for municipal investors in 2014?

If you agreed with the overwhelmingly lukewarm consensus outlook for the municipal bond market in 2014, you would be pleasantly mistaken after the first quarter. The consensus view called for muted municipal returns due to rising rates on the back of continued Federal Reserve tapering and a strengthening economy. In fact, the municipal market is off to a blistering start! What happened?

Two key factors led to solid returns for the municipal market in the first quarter of 2014:

  • U.S. Treasury rates have rallied, and
  • a positive technical condition has reasserted itself in the market.

Treasurys rally amid weak economic data

Treasury market rates have rallied as a result of weaker-than-expected economic data (potentially weather related), economic growth concerns in Europe and the emerging markets, and the Russian annexation of Crimea from the Ukraine. This series of events led to a "flight to quality" and lower U.S. Treasury rates. Municipal rates are directionally correlated to U.S. Treasury rates.

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10-year municipal bond yield vs. 10-year Treasury Yield

10-year municipal bond yield vs. 10-year treasury yield

Data: MMD, as of April 2014. 10-year municipal bond represented by the AAA general obligation 10-year municipal bonds.

Chart shown is for comparison purpose only

A resurgence of positive technicals

As we entered the first quarter of 2014, the municipal market was primarily influenced by: (1) the fear of rising rates, (2) negative headlines surrounding the Detroit bankruptcy filing, (3) continuing concerns over Puerto Rico, (4) tax-loss selling in fixed income to offset strong equity market gains.

However, a reversal of 2013's $70 billion in municipal bond fund outflows in conjunction with less-than-forecasted new issuance resulted in positive supply-demand technicals for the municipal bond market during the quarter; conditions were similar to those seen in the 2011 and 2012 calendar years. Year-to-date supply is down 26% relative to the same period in 2013. At the close of the first quarter, we are seeing investment banks further revising (downsizing) their forecast for the balance of 2014. (Data: Municipal Market Data, as of April 2014.)

Municipal bonds’ return for the 3-month period ended March 31, 2014, was 3.32% (as measured by the Barclays Municipal Bond Index), and municipal bonds were the best-performing major asset class within the broader fixed income market. (Data: Bloomberg, as of April 2014.)

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Barclays index return

Barclays index return

Data: Morningstar, as of April 2014. Return data based on the below Barclays Indices. Index performance returns do not reflect any management fees, transaction costs, or expenses. Indices are unmanaged and one cannot invest directly in an index. Refer to disclosures below for index definitions.

Chart shown is for comparison purpose only

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Municipal bond mutual fund flows

Municipal bond mutual fund flows

Data: J.P. Morgan Municipal Research and Lipper, as of April 2014.

Chart shown is for comparison purpose only

As April came to a close, we saw a continuation of these positive trends. This was evidenced by the lack of the seasonal effect normally expected during tax-filing time. Typically during this period flows turn negative; however, flows shifted to slightly positive during this time.

Additionally, demand for municipal bonds has been bolstered by higher 2013 tax rates (increases in state and federal taxes as well as the additional 3.8% healthcare surcharge). We expect that after investors meet with their accountants the reality of these tax hikes will further add to the appeal of the asset class, potentially prolonging the improved technical environment within which we have recently been operating.

The views expressed represent the Manager's assessment of the market environment as of March 2014, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager's views.

The Barclays High-Yield Municipal Bond Index measures the total return performance of the long-term, noninvestment grade tax-exempt bond market.

The Barclays Municipal Bond Index measures the total return performance of the long-term, investment grade tax-exempt bond market.

The Barclays U.S. Corporate High-Yield Index is composed of U.S. dollar–denominated, noninvestment grade corporate bonds for which the middle rating among Moody’s Investors Service, Inc., Fitch, Inc., and Standard & Poor’s is Ba1/BB+/BB+ or below.

The Barclays U.S. Corporate Investment Grade Index is composed of U.S. dollar–denominated, investment grade, SEC-registered corporate bonds issued by industrial, utility, and financial companies. All bonds in the index have at least one year to maturity.

The Barclays 3–15 Year Blend Municipal Bond Index measures the total return performance of investment grade, U.S. tax-exempt bonds with maturities from 2 to 17 years.

The Barclays U.S. Aggregate Index is a broad composite that tracks the investment grade domestic bond market.

The Barclays U.S. Treasury Index measures the performance of U.S. Treasury bonds and notes that have at least one year to maturity.

Carefully consider the Funds' investment objectives, risk factors, charges, and expenses before investing. This and other information can be found in the Funds' prospectuses and their summary prospectuses, which may be obtained by visiting or calling 800 523-1918. Investors should read the prospectus and the summary prospectus carefully before investing.


Investing involves risk, including the possible loss of principal.

Past performance does not guarantee future results.

Fixed income securities and bond funds can lose value, and investors can lose principal, as interest rates rise. They also may be affected by economic conditions that hinder an issuer’s ability to make interest and principal payments on its debt. The Funds may also be subject to prepayment risk, the risk that the principal of a fixed income security that is held by the Funds may be prepaid prior to maturity, potentially forcing the Funds to reinvest that money at a lower interest rate.

High yielding, non-investment-grade bonds (junk bonds) involve higher risk than investment grade bonds.

Funds that invest primarily in one state may be more susceptible to the economic, regulatory, regional, and other factors of that state than geographically diversified funds.

Substantially all dividend income derived from tax-free funds is exempt from federal income tax. Some income may be subject to the federal alternative minimum tax (AMT) that applies to certain investors. Capital gains, if any, are taxable.

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