(Bloomberg) -- Paul Malloy, the head of municipals at Vanguard Group Inc., is seeing signs of a revival in the $4 trillion market that he expects will stretch into 2023, in part as this year’s surge in yields lures investors back to state and city debt.
Yields on benchmark 10-year munis are still more than double their level at the start of the year, even after dropping in recent weeks on signs of ebbing inflation pressure. What’s more, pandemic relief aid and swelling tax revenue have helped shore up the finances of US states and local governments.
It’s “a really great point to re-enter municipals for the long-run given the increased yields in the marketplace on top of some of the best credit quality that we’ve had in decades,” Malloy, who oversees $228 billion, said in an interview. “It sets us up for a 2023 that we like to call a muni renaissance.”
The Bloomberg municipal bond index is down 8.2% this year, on pace for the worst annual performance since 1981, after eight straight years of gains. Withdrawals from muni-bond mutual funds have topped $100 billion this year, Refinitiv Lipper US Fund Flows data show.
“A lot of bad news is already priced in and a lot of it was driven by the outflow cycle,” Malloy said. “The outflow cycle took munis cheaper than what current economic conditions would say they should be. When you are trying to invest you are looking at the risks and you look at the valuation, and that is a very good trade off in our opinion at this point for the investment-grade municipal space.”
Aggressive Federal Reserve rate hikes, the threat of recession and market volatility spooked municipal investors in 2022. But with the central bank now signaling smaller rate hikes starting as soon as this month, and with the fund manager seeing angst over an economic slowdown largely priced in, Vanguard is looking for signs of stabilization in Treasuries and lower volatility.
Those are the preconditions that would give investors more confidence to put more money back into municipal debt, Malloy said.
“We do believe flows will turn around at some point next year and will be beginning what is a typical trend of a muni inflow cycle,” although pinpointing whether that will occur in the first or second half of 2023 is difficult, he said.
Not only does Vanguard expect demand to pick up, but it also sees municipal issuance in 2023 staying close to $400 billion, mostly unchanged from its projection for 2022, Malloy said.
“It’s going to be much much more difficult to get to an outright negative total return in municipals for the foreseeable future,” he said.
--With assistance from Marisa Gertz.
(Updates performance, adds comment.)
©2022 Bloomberg L.P.