The municipal market's credit and rate volatility last month could spark buying opportunities, according to a report from BlackRock Inc.
Price declines in April coupled with growing interest rate volatility, seasonally weak demand, and a surge in new issuance to a record $37.8 billion when compared to historic norms, contributed to a weaker overall tone, according to the May 11 report entitled, "A Taxing Month for Munis."
"Demand was weak leading into tax time followed by a recovery after April 15," analysts Peter Hayes, James Schwartz, and Sean Carney said in the report.
While outflows were mostly contained to municipal money funds, municipals overall saw $691 million of inflows in April, bringing the year to date total to roughly $10.1 billion, the analysts pointed out.
"We view volatility-induced pullbacks as buying opportunities and are looking to take advantage of some of the recent weakness in both rates and credit spreads," they said.
While much of the month's rate volatility was fueled by expectations of a possible Fed rate increase in June, the analysts said mixed economic signals were also a contributing factor.
The month saw higher U.S. inflation expectations, a stabilizing dollar and oil price, and an upturn in European interest rates, the analysts said.
On a positive note, munis underperformed U.S. Treasuries on the month due to swell in monthly new issuance - of which new money accounted for 42% versus refunding, the report said.
Overall, rates were higher, the yield curve was steeper, and muni-to-Treasury ratios remained historically compelling, according to the analysts.
"The attractive taxable/tax-exempt ratio typically attracts a larger, less-sensitive buyer of the asset class, which should underpin the market to some extent," the analysts wrote.
On Monday, the municipal to Treasury ratio for 10- and 30-year maturities was at 101.7% and 108%, respectively, according to Municipal Market Data.
Potential opportunities aside, the analysts said the municipal market is not without some fiscal tension as fiscal year 2016 nears.
"Credit fundamentals generally remain strong, but state revenue growth is slow and could make for a challenging budget season," the report said.
The analysts cited a U.S. Census Bureau report that indicated state government tax revenue increased 2.2% in fiscal year 2014 from fiscal 2013 - the fourth straight annual increase.
That revenue strength was led by general sales and gross receipts, which were up 4.8%.Individual income taxes of $310.8 billion remained the largest source of state government tax revenues, but only grew 0.4% from the previous year, the analysts noted.
The analysts said the budget season is not as rosy for Puerto Rico, as the commonwealth may resort to liquidity-boosting measures that include a proposal from Gov. Alejandro Garcia-Padilla for $1.5 billion in spending cuts and a potential proposal for an increase in the sales tax rate to boost revenue collections.
"We see a reasonable risk of a government shutdown and liquidity crisis in the coming months," the analysts wrote.
Hayes is head of the municipal bonds group, Schwartz is head of municipal credit research, and Carney is head of municipal strategy.
