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Are municipal bonds poised for a comeback?

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The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance fund. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results.

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      By James H. Evans, CFAChief Investment Officer, Fixed Income, Parametric

      New York - After setting a record low of 0.78% at the beginning of March, the yield on a 10-year AAA municipal bond has increased to 1.86%, a one-year high and in line with a five-year average. The size and speed of the move is similar in nature to sell-offs witnessed in 2008, 2010-2011 (the "Meredith Whitney" period), and the 2013 Taper Tantrum. Many muni participants look on those weaker markets as having been an attractive entry point. A similar opportunity may be emerging.

      What's happening with municipal bond yields?

      Throughout January and February, municipal yields were dragged down in sympathy with Treasury yields. However, municipals are a retail-dominated product, and individual investors began to balk as the yields on 10-year investment-grade municipals dived under 1%. While evaluation prices went up, liquidity thinned and the market ceased to facilitate trade. Muni mutual fund and ETF outflows began the second week of March and continue this week. Combined with retail selling driven by both profit taking and rebalancing, the market is seeing more sellers than buyers. As a result, dealers and market participants have backed up their bids and yields have spiked dramatically.

      Good news about muni yields

      Muni yields reflect real rates of return that we find compelling. With absolute yields back to long-term averages, we believe munis can resume their place as an attractive source of after-tax income and as a diversifier to equity and equity-like risk found in other areas of fixed income. This may be particularly valuable in this environment. In addition, market moves over the past two weeks have cheapened munis' relative valuations versus taxable vehicles to a point rarely witnessed in history. Muni investors have been typically rewarded with outperformance when we get to these types of valuations.

      While this turmoil persists, we see these factors as supporting investment-grade municipals and corporates:

      • We expect Treasury yields to be low and close to zero for quite some time.
      • We view investment-grade municipals and corporate yields as attractively valued.
      • We anticipate further unprecedented fiscal and monetary support from the US government and the Fed, including direct support to corporations and municipalities.

      Daily updates

      While the market is undergoing exceptional volatility, we'll post the change in yields from the previous Friday and the daily valuation of municipals and corporates. Liquidity will likely change significantly from day to day.

      On Tuesday both municipal and corporate bonds continued to exhibit wide bid-offer spreads.1 For those looking to rebalance or liquidate, particularly with smaller lots, liquidity is available but may result in a -3% to -10% discount from the pricing service evaluation. We're seeing the same liquidity this morning.

      Yields680pxValuation680px

      Bottom line: We still believe that investment grade municipal and corporate bonds could weather this storm better, helping to provide more attractive income and return opportunities than comparable maturity Treasuries. In our view, professional credit oversight will continue to be very important going forward to assist investors in avoiding deteriorating credits.