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Quarterly Income Outlook: Sorting out mixed messages from the Fed and Congress

Chief Income Investment Officer Payson Swaffield notes that bond market investors are confronted with stark policy contrasts coming from Washington - the relative clarity of the US Federal Reserve compared with the murky picture posed by the congressional stalemate and the presidential election.
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By Nisha Patel, CFADirector Fixed Income, Portfolio Management, Parametric

New York - In a low-yielding environment, we favor the intermediate to long part of the curve.

The muni market has seen a tremendous rebound since early March, especially in the high-quality space. From here, the market outlook will be dependent upon two key factors: What flows look like into the asset class, and how much new issue supply the market sees over that timeframe.

Today's low absolute yields may give investors pause before investing into the asset class. However, in what may remain a low-yielding environment for quite some time, muni valuations today remain attractive relative to other fixed income asset classes. We currently favor the intermediate to long part of the curve, especially as short maturity yields have plummeted, and the steeper yield curve provides more income to investors.

Additionally, a recent surge of issuance of taxable muni bonds has resulted in very attractive valuations of taxable muni bonds compared to similarly rated corporate bonds across the yield curve. We think nontraditional buyers will continue to look to this space for more value, especially as the Fed's secondary market purchases keep corporate bond deals depressed for quite some time.

Access to capital markets has also significantly improved for issuers since early March, and we expect issuers across all sectors to take advantage of these low financing yields over the course of the next few months.

From a credit perspective, July's postponed tax payments will be telling, at a state level, of what the true tax payments will look like and how much of a gap that will truly create on a state level. Local credits should remain more defensive, as their revenue stream is a bit more resilient due to the dependency on property tax collections.

Highly impacted sectors, such as healthcare, transit and higher education, have seen spreads tighten recently. However, spreads remain elevated compared to pre-crisis levels. As a recovery continues, it will be important to play defense in these sectors, but also be proactively looking to identify inefficiencies in these sectors going forward.