When geopolitical risk takes precedence over interest rate risk

Market Realist

Geopolitical risks and the municipal bond investment opportunities (Part 1 of 10)

Poised for a comeback

Municipal bonds may be poised for a comeback this year. The total returns on municipal debt came in at 3.32% in the first quarter of 2014, as measured by the Barclays Municipal Bond Index. This was a nice turnaround considering their bleak performance in 2013, when they clocked a negative return of 2.55%, their worst performance since 1994.

In contrast, high-yield U.S. debt (JNK), as represented by the Barclays U.S. Corporate High-Yield Index, clocked in 3% in total returns in Q1 2014, while the S&P 500 Index (VOO) returned 1.8% over the same period. High-Yield Debt (HYG) and the S&P 500 Index (VOO) were one of the best performers over the past one year amongst major asset classes, returning 7.5% and 21.9%, respectively, while munis have returned just 0.4%. The Barclays Municipal Bond Index is up 4.5% YTD (April 23, 2014).


The returns on munis was less than the returns on the Barclays Long-Treasuries Index and the Barclays U.S. 10+ Year Corp Index, which came in at 7.1% and 6.2%, respectively.

One of the best performing muni bond funds in the first quarter was the Market Vectors Long Municipal Index ETF (MLN). The price of MLN has appreciated by 7.19% in the first quarter of 2014. YTD total return on MLN is 9.08%. The price of another ETF, the SPDR Nuveen Barclays Build American Bond (BABS) has appreciated by 7.5% in the first quarter of 2014 and has clocked total returns of 9.02% YTD.

Staging a rally on the flight-to-safety and Ukraine

With the onset of the Fed’s tapering of monthly asset purchases in December 2013, markets expected interest rates to rise and bond prices to fall. Instead, the emerging market turmoil compelled investors to shift to safer securities such as the U.S. Treasuries. Fund managers cut their holdings in Emerging and Frontier Markets to move them to safer U.S. assets, due to which bond prices in the U.S. markets rose. In a similar situation, the ongoing Russia-Ukraine tensions in the Crimea since February, also precipitated a flight-to-safety. Yields on 30-Year, AAA-rated General Obligation municipal bonds (MLN) fell by 16 basis points over the period January-March 2014. Comparable yields for Treasury securities (TLT) fell by 41 basis points over the same period.

To know about how emerging market flows have impacted the U.S. debt market, read the series, How has emerging market turmoil impacted the US debt market?

Economic hibernation and financial markets

Last winter was especially severe, impacting all sectors of the economy. Production stoppages, delivery snarls, and slower to non-existent (as some retailers have reported) retail traffic were some of the symptoms of the winter hibernation in economic activity. As a result, economic data releases were very disappointing for investors in the first two months of the year. Investors were also unable to gauge how much of the slowdown was attributable to poor weather conditions and questioned whether the economic recovery was really robust. This factor too resulted in increased demand for safer U.S. fixed income assets like Treasuries and municipal securities.

The S&P 100 (OEF) component Citigroup (C) was rated the number one underwriter for municipal bonds in Q1 2014 by Thompson Reuters. Citigroup (C) was the underwriter for deals worth over $8.1 billion in Q1 2014. For more on underwriting municipal bonds, read Part 4 of this series.

To read about issuance trends in the muni market, move on to Part 2.

Continue to Part 2

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