Muni market tailwinds turn to headwinds

Muni bonds outrun rising rates

April update

? Municipals posted gains in March despite rapidly rising interest rates.

? Although valuations appear rich, we expect supply and demand dynamics to remain favorable.

? Federal aid to state and local governments should help underpin municipal fundamentals.

Peter Hayes, Head of the Municipal Bonds Group James Schwartz, Head of Municipal Credit Research Sean Carney, Head of Municipal Strategy

Market overview

While most fixed income asset classes posted negative returns for the month of March, the broad S&P Municipal Bond Index posted a gain of 0.55%. It was a challenging month for bond markets generally as the passage of additional fiscal stimulus and rising optimism for further reopening of the economy drove interest rates higher. (Bond prices fall when interest rates rise.) Municipals, however, rebounded from their temporary value-driven correction of late February. Longer duration and lower credit quality muni bonds were the better performers.

Issuance at $45 billion was 59% above the 5-year average for the month of March. A large and diverse new-issue calendar offered opportunity for investors to put cash to work at attractive levels. As a result, new issues were oversubscribed by 6.5 times on average versus just 4.6x in February. Notably, taxable deals fell to just 19% of total issuance, down from 31% earlier in the year, as higher interest rates made the advance refunding of tax-exempt debt in the taxable municipal market less economical.

After a brief outflow early in the month, retail demand firmed alongside strong muni bond performance. Inflows were led by long-term muni bond mutual funds.

Although valuations remain historically rich, we maintain a constructive view on the asset class. Supply is expected to be manageable, and the extension of Tax Day should help the market avoid weakness that is typical in April due to investors selling securities to pay tax bills. Additionally, the $350 billion in direct aid to state and local governments provided by the American Rescue Plan should help underpin municipal fundamentals, which have already benefited from better-than-expected revenue collections.

Strategy insights

We maintain a neutral stance on duration (interest rate risk) within a barbell yield curve strategy. We continue to hold a preference for lower-rated credits and sectors that have been more impacted by the pandemic such as transportation, travel-related (hotel tax, airport, etc.) and health care.

Duration

Short

Apr Neutral

Mar

Long

Yield curve Barbell strategy, preferring 0-5 and 20+ years

Overweight ? Higher quality state and essential-service bonds ? School districts and local governments supported by

property taxes ? Flagship universities and strong national and regional

health systems ? Select issuers in the high yield space

Underweight ? Speculative projects with weak sponsorship, unproven

technology or unsound feasibility studies ? Senior living and long-term care facilities ? Small colleges, student housing and single-site hospitals

April 2021|Municipal Market Update

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What the American Jobs Plan could mean for munis

The Biden Administration unveiled its infrastructure proposal called the "American Jobs Plan" totaling $2.25 trillion, the first of an anticipated two-part "Build Back Better" plan. We estimate that this initial proposal impacts 80% of the municipal market. The package extends over eight years, with revenues derived from an anticipated restructuring of corporate and individual taxes.

Although details remain limited, it seems likely that municipal issuers will be incentivized to leverage federal funding to finance new infrastructure projects, which could lead to increased bond issuance. However, any increase in supply is likely to be met with increased demand for tax shelter from both institutional and individual investors, resulting in a relatively muted impact on market performance. Notably, additional sources of demand could promote historically rich valuations and act as a backstop if the market were to face more adverse conditions. While a reinstatement of the tax exemption for advance refunding of tax-exempt debt and/or a revival of a Build America Bonds-type program would create more significant market implications, we view these as lowprobability events for the near term.

The proposal is positive for most market segments as the plan targets all aspects of the U.S. economy. The funding will focus on community and transportation infrastructure, R&D/workforce/manufacturing, and elder/health care. However, the allocation of funds has to be taken in context with the recently passed American Recovery Act, which provided $350 billion to state and local governments and will have a more immediate impact on improving the fiscal health of many of the largest issuers in the municipal market. Additionally, given the revision of the tax policy needed to fund the program, an extensive negotiation within Congress is anticipated, with prospects of reconciliation likely if true bipartisan legislation remains elusive.

Municipal and Treasury yield movements

2.5%

2.42

2.0 1.74 1.75

1.5

1.0

0.94

0.5 0.16

0.0 0.14

2-year AAA Muni 3/31/21

0.51

5-year 2/28/21

1.12

10-year

30-year

Treasuries 3/31/21 2/28/21

Sources: BlackRock; Bloomberg.

Municipal performance

S&P Municipal Bond Index Long maturities (20+ yrs) Intermediate maturities (3-15 yrs) Short maturities (6 mos-4 yrs) High yield High yield (ex-Puerto Rico) General obligation (GO) bonds California New Jersey New York Pennsylvania Puerto Rico Source: S&P Indexes.

MAR 2021 0.55% 0.92% 0.49% 0.17% 0.72% 0.79% 0.52% 0.59% 0.77% 0.58% 0.52% 0.27%

YTD -0.26% -0.02% -0.45%

0.13% 1.77% 1.90% -0.59% -0.52% 0.29% -0.18% -0.14% 1.04%

Investment involves risk. The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. There may be less information available on the financial condition of issuers of municipal securities than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. A portion of the income from tax-exempt bonds may be taxable. Some investors may be subject to Alternative Minimum Tax (AMT). Capital gains distributions, if any, are taxable. Index performance is shown for illustrative purposes only. You cannot invest directly in an index. Past performance is no guarantee of future results.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of April 12, 2021, and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. There is no guarantee that any forecasts made will come to pass. Any investments named within this material may not necessarily be held in any accounts managed by BlackRock. Reliance upon information in this material is at the sole discretion of the reader.

? 2021 BlackRock, Inc. All Rights Reserved. BLACKROCK is a trademark of BlackRock, Inc. All other trademarks are those of their respective owners.

Prepared by BlackRock Investments, LLC, member FINRA.

Not FDIC Insured ? May Lose Value ? No Bank Guarantee

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