Monthly Municipal Market Update, January 2023

January month in review

U.S. equities and fixed income each notched solid gains to close out the first month of 2023, fueled by investor optimism that the Federal Reserve (Fed) is nearing the end of its rate-hike cycle.^Footnote1

This optimism was ultimately supported by the Fed’s decision on 1 February to raise rates by just a quarter percentage point, slowing the pace of its hikes for the second consecutive time. The benchmark lending rate now sits at 4.50%-4.75%, a level not reached since 2007. In a statement released following the meeting, Fed officials acknowledged that despite recent improvement in inflation printings, “The committee anticipates that ongoing [rate] increases . . . will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive.” Many interpret this statement to imply the Fed is likely to raise rates by another 25 basis points (bps) at both its March and May meetings; this would align with the majority of Fed officials’ latest expectations (as of December) for rates to ultimately peak in the 5.00%-5.25% range.^Footnote2

The Bloomberg U.S. Treasury Index returned 2.51% in January, its strongest monthly gain since January 2020.^Footnote3 The 1-, 5-, 10- and 30-year tenors of the U.S. Treasury yield curve closed the month at 4.69% (-4 bps), 3.63% (-39 bps), 3.52% (-36 bps), and 3.65% (-31 bps), respectively.^Footnote4

A broad fixed income rally and favorable municipal market technicals – specifically the “January effect,” which we explore in this month’s “In Focus” section – resulted in a strong month of performance for the asset class. The Bloomberg Municipal Bond Index gained 2.87% in January, outperforming the Treasury index by 36 bps over the month. The lower-quality and taxable sectors of the muni market fared even better: Bloomberg’s High Yield Municipal Bond and Taxable Municipal Bond indices returned 4.44% and 5.04% in January, respectively.^Footnote5  AAA Municipal Market Data (MMD) yields declined dramatically across the curve over the month, with the 1-, 5-, 10- and 30-year tenors closing at 2.28% (-58 bps), 2.05% (-47 bps), 2.19% (-44 bps), and 3.20% (-38 bps), respectively.^Footnote6  Municipal-to-Treasury ratios currently sit at 12-month lows, while tax-equivalent spreads from AAA munis to Treasuries are negative out to five years.^Footnote7*

January’s municipal market issuance of $21.9 billion represented a relatively dramatic year-over-year decline (down 19% relative to January 2022).^Footnote8  A good portion of this can be attributed to uncertainty surrounding the path of future Fed rate decisions, the possibility of recession on the horizon, and still-elevated inflation.

Following two weeks of outflows from muni funds to kick off the year, flows for the asset class reversed course: Weekly and monthly reporting funds posted three consecutive weeks of inflows to close the month. Even with the surge of funds into the asset class, however, year-to-date flows were still negative for the period ending 1 February, totaling $1.7 billion. It appears likely that the longest outflow cycle on record, totaling $127.4 billion over 53 weeks, is now in the rearview mirror.^Footnote9

January effect in focus: Muni market begins year with strong returns

Key municipal market indices – the Bloomberg Municipal Bond Index and Bloomberg High Yield Municipal Bond Index – posted respective returns of 2.87% and 4.44% in January.^Footnote10  These relatively robust returns were largely driven by a municipal market phenomenon known as the January effect. Essentially, municipal asset prices tend to appreciate in January as seasonal factors bring elevated demand coupled with limited supply.

Although the effects of this phenomenon are not guaranteed every year, the necessary conditions presented themselves this year, and ultimately resulted in the strongest January performance for munis since 2009 (see Figure 2). Given 2022’s market downturn, investors engaged in a flurry of tax-loss harvesting activity before the year ended. This, coupled with about $27 billion of December 2022 maturities, roughly $5.2 billion in called bonds, and approximately $11.1 billion in tax-exempt coupon payments gave investors a plethora of reinvestment capital.^{Footnote11,12}  These tailwinds, in addition to attractive yields, constructive credit fundamentals, and a relatively low monthly supply of just $21.9 billion, contributed to the municipal market’s strong performance.^Footnote13

To learn more about investing in municipals at PIMCO, please visit pimco.com/munis.

¹ Caitlin Ostroff and Eric Wallerstein, “Stocks Cap Strong January With Gains as Investors Look to Fed Meeting,” Wall Street Journal, 31 Jan 2023 Return to content↩

² "Nick Timiraos, “Fed Approves Quarter-Point Rate Hike, Signals More Increases Likely,” Wall Street Journal, 1 Feb 2023 Return to content↩

³ Bloomberg, 31 Jan 2023Return to content↩

⁴ Thomson Reuters TM3 MMD Interactive Data, 31 Jan 2023Return to content↩

⁵ Bloomberg, 31 Jan 2023 Return to content↩

⁶ Thomson Reuters TM3 MMD Interactive Data, 31 Jan 2023Return to content↩

⁷ Jessica Lerner and Christine Albano, “Munis close out January relatively steady,” The Bond Buyer, 31 Jan 2023Return to content↩

⁸ The Bond Buyer: Primary Market Statistics – A Decade of Bond Finance, 31 Jan 2023; Bloomberg Corporate Issued Municipals Data, 3 Feb 2023Return to content↩

⁹ Refinitiv Lipper US Flow, J.P. Morgan, 2 Feb 2023. Note: combined weekly and monthly flowsReturn to content↩

¹⁰ Bloomberg, 31 Jan 2023Return to content↩

¹¹ Ibid Return to content↩

¹² Siebert’s New Improved Municipal Cash Flow 2023 Report, 31 Dec 2022 Return to content↩

¹³ The Bond Buyer: Primary Market Statistics – A Decade of Bond Finance, 31 Jan 2023; Bloomberg Corporate Issued Municipals Data, 3 Feb 2023Return to content↩