Investors are pulling out of municipal bond funds at the fastest rate in over a year as they sell assets to pay income taxes and try to protect earnings in the face of signals that the Federal Reserve will keep interest rates higher for longer.
Municipal bond funds had outflows of $1.5 billion in the week ending Wednesday, the biggest drop since December 2022, according to LSEG data. The outflow broke 8 consecutive weeks of capital inflows and sparked debate about whether the outflow cycle will begin this week.
Kathleen McNamara (Kathleen McNamara), senior municipal bond strategist at UBS Global Wealth Management (UBS Global Wealth Management), said the tax season was one reason for the sell-off because investors often sell tax-free municipal bonds to repay their debts around the April 15 filing deadline. Another factor, she said, was volatility and rising US Treasury yields, which pushed “uneasy” retail investors aside.
Vikram Rai, head of municipal bond market strategy at Wells Fargo & Co. (WFARGO), said, “There are some protective sell-offs underway.” He said investors are worried that the Fed will not cut interest rates, inflationary stickiness, and global tension.
Over the past few months, the yield on 10-year US government securities has risen as the market adjusted for interest rate cuts that were later than expected.
John Miller, head of First Eagle Investments' high-yield municipal credit team and chief investment officer, said that in April alone, 10-year US Treasury bonds rose by nearly 40 basis points, and have risen by nearly 75 basis points so far this year, due to a series of strong economic data and “slightly disappointing” inflation reports. Municipal net asset value declined this month. “There are concerns that the Federal Reserve may not cut interest rates at all this year.”
“Coupled with the loss of liquidity during the tax season, I think this is the reason for the recent capital outflow,” Miller said.
Wells Fargo's Rai said he will wait to see traffic data for the next three to four weeks before drawing a conclusion on whether the latest data has become a trend.
A Barclays report on Friday showed that municipal fund flows tend to follow the US Treasury bond market, and large fluctuations may drive “large-scale and long-term” capital outflows. The strategist led by Mikhail Foux (Mikhail Foux) said in the report: “As a result, this week's capital outflow is unlikely to be one-off, especially if the sell-off continues.”
Bank of America Securities (BofA Securities Inc., BofA) strategists said they think a buying opportunity is coming soon.
The strategist wrote in a report on Friday: “Market pessimism is becoming excessive as the market debates the extreme circumstances of inflation and possible positions the Federal Reserve may take.” The market is about to enter a turning point, and investors should be prepared to step in the short term.”