(Bloomberg) -- US state and local debt is headed for its worst month in a year, with the Federal Reserve’s hawkish pause sending yields soaring and erasing gains from the first half of 2023.
Munis have slumped 3.33% so far in September, according to data compiled by Bloomberg, on track for its poorest performance since a 3.84% drop the same time last year.
Yields on 10-year munis jumped almost 50 basis points since Sept. 20, after investors sold bonds as they digested the Fed’s message that it would keep borrowing costs higher for longer. Treasury yields have also been climbing, with the benchmark 10-year rate rising to its highest level since 2007 this week.
On Friday, the market rebounded slightly, with municipal yields falling as much as 5 basis points across the curve.
“At the same time that rates have risen, new issue supply has picked up somewhat and yields have had to move higher to meet demand,” said Daniel Solender, head of municipal debt at Lord Abbett & Co.
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Investors yanked $1.2 billion from municipal-bond funds in the week ended Wednesday, according to Refinitiv Lipper US Fund Flows data. Those outflows may continue to mount, said Barclays Plc’s municipal-bond strategists led by Mikhail Foux in a research note entitled “September to Forget” published Friday.
“The muni market already feels somewhat vulnerable, and heavier outflows will likely re-start yet again after such a dramatic rates move,” the group said. “Meanwhile, supply is expected to remain heavy in October, likely putting even more pressure on the market.”
September’s dismal performance could continue going into next month, according Kathleen McNamara, senior municipal strategist at UBS.
“Weaker technicals and negative fund flows are likely to put pressure on performance in October,” she said in a report published Thursday.
Eric Kazatsky, municipal strategist at Bloomberg Intelligence, noted that while historical trends have been “unfavorable” in October, “the current tumult in interest rates has the greatest potential to turn the month into a returns house of horrors.”
The silver lining is that higher yields will help lure investors to the asset class, said McNamara.
“On the bright side, absolute yields on high-quality munis already look attractive, in our view,” she said. “An additional bout of volatility in the October, November time frame is apt to prompt a good buying opportunity for long-term investors seeking after-tax income opportunities.”
--With assistance from Amanda Fung.
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