Muni Performance, Demand Expected to Be Solid in Final Act of 2016

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Heading into the fourth quarter of 2016, municipal experts are confident that municipals will offer investment opportunities and continue to perform as well as they have so far this year.

Global turmoil overseas will keep the broader U.S. bond market in the spotlight, and will particularly allow municipal investors to take advantage of value in the tax-exempt market before the curtain closes on the fourth quarter, municipal experts said last week.

They spoke to The Bond Buyer just as Federal Reserve Board policy makers were wrapping up the September policy meeting where they later announced plans to stand pat on interest rates and hinted at possible December move.

"Although our domestic recovery has been uneven, global economic weakness accompanied by near-zero and even negative interest rate policies abroad have only enhanced the demand for municipals," Jeffrey Lipton, managing director and head of municipal research and strategy at Oppenheimer & Co., said in an interview on Sept. 21.

"The demand and resiliency for municipals is illustrated by the 50 consecutive weeks of positive mutual fund flows that have shown cash additions largely accelerating week to week," Lipton said last week – the day before Lipper reported the 51st week of inflows for the week ended Sept. 14 after weekly reporters generated $517.593 million of new cash, following $485.522 million the previous week.

That strong demand has resulted in a year-to-date total return of about 3.85%, Lipton said.

Overall, the experts said the municipal market weathered a storm of volatility in other sectors and is poised to end the year with the same strength and stability, despite the potential for a rate hike.

"Brexit came and went and munis handled it very well," said Mark Paris, head of portfolio management and trading at Invesco, referring to the United Kingdom vote to leave the European Union. He said municipals are "preferred" by the Atlanta-based investment firms' clients due to their stability and positive flows across high yield and high-grade mutual funds.

"This year, we have seen munis can handle a lot of volatility in other sectors and not get sucked into that," Paris said.

Jeff MacDonald, director of fixed income strategies at Fiduciary Trust Company, said the firm's municipal portfolios are well positioned ahead of any potential interest rate movements – and are poised to take advantage of eventual higher rates.

"It's frustrating that rates have been this low for this long, especially for fixed-income investors," he said. A fair number of clients with maturing bonds due in the next 12 to 18 months hope to be able to put that money back to work in the municipal market and reinvest at higher rates, he said.

"We have healthy employment and inflation is moving in the right direction," said MacDonald, who believes the Fed is "very close" to its dual mandate necessary for a rate hike.

"The response to that will be a slow and steady normalization of policy," he said. "We do foresee an environment of higher rates and we are positioned defensively."

Lipton of Oppenheimer said he has reservations about the Fed's next move and that leads him to expectations of a possible December rate hike at the earliest, and subsequent rally on the long end.

"We are now questioning the relevance of the Fed's dual mandate of full employment and price stability as well as its existing inflation target of 2%," he said. "Market volatility for the year has been the by-product of a number of factors, including global Central Bank uncertainty regarding the timing, direction and magnitude of interest rate movements, and the perceived effectiveness of current policy tools," he added.

Paris said municipals will continue to benefit from healthy demand as represented by steady inflows that are fueled by strong liquidity and overall stability through year end.

His portfolios are well positioned ahead of any interest rate moves by the Fed – which could potentially act as early as December, he predicted.

"We think the market will hang in very well, and we don't think yields will change that drastically going forward," he added.

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