Muni Market's Seven-Year Novel: November Gains

The municipal bond market is gearing up for another November filled with gains, marking a seven-year streak of positive returns. This resilience, despite market fluctuations and geopolitical events, can be attributed to a combination of favorable supply and demand dynamics, tax policy changes, and demographic shifts. Let's delve into the factors driving this remarkable trend.



Supply and demand dynamics have played a significant role in the muni market's November gains. According to Western Asset, fund inflows have remained robust, with $305 million of net inflows reported during the week ending November 13, marking the 20th consecutive week of inflows. This strong demand, coupled with limited supply conditions, contributed to the positive performance of the muni market during November. Additionally, issuance levels have remained elevated, with YTD issuance of $451 billion, up 41% YoY, driven by tax-exempt issuance up 44% and taxable issuance up 8%.



Tax policy changes have also influenced muni market performance during this period. The potential expiration of the Tax Cuts and Jobs Act (TCJA) of 2017 in 2025 could increase demand for munis, as investors seek to maximize their after-tax income. Moreover, state-level tax policy changes, such as Illinois' proposed income tax surtax, could affect regional demand for munis.

Demographic shifts, particularly increased demand for housing and infrastructure projects, have significantly influenced municipal bond issuance and yields. The municipal bond market has seen elevated supply levels, with YTD issuance of $451 billion, 41% higher YoY. This surge in issuance is driven by the need for infrastructure investments, including housing, to accommodate population growth and evolving demands. Despite the increase in supply, demand has remained robust, with net inflows into municipal mutual funds totaling $38 billion YTD.



Investors' risk preferences have evolved during the seven-year streak of November gains in the muni market. Initially, demand for higher-yielding munis was driven by investors seeking higher returns in a low-interest-rate environment. This preference led to increased inflows into high-yield muni funds. However, the shift in risk preferences has also extended to taxable munis, with issuance of taxable munis increasing by 8% year-over-year in 2024. This trend reflects investors' desire for yield and liquidity, even in taxable securities.

Municipal credit quality and default rates have remained resilient during this period. Franklin Templeton's Municipal Ladder fund focuses on higher-quality bonds to protect against credit deterioration and provide liquidity. Despite the fund's underperformance in Q3 2024 due to its underweight in BBB-rated bonds, its duration exposure helped relative results, benefiting from lower muni yields across the curve. Western Asset also reports that the Bloomberg Municipal Index returned 0.12% during the week ending November 19, with lower-rated issuers posting positive total returns and outperforming higher-rated ones. These trends suggest that investors are cautiously considering lower-rated investment-grade munis while maintaining a preference for higher-quality bonds. Default rates in the muni market have remained low, with only two defaults reported in 2024 by Municipal Market Analytics.

In conclusion, the muni market's seven-year streak of November gains is driven by a combination of supply and demand dynamics, tax policy changes, demographic shifts, and evolving investor risk preferences. As the market continues to adapt to these factors, investors can expect further gains in the coming years, provided that credit quality remains resilient and default rates remain low.