Traders Surge Into the $4 Trillion Municipal Bond Market, Boosting Trading Volumes

Investors are flocking to the $4 trillion municipal bond market to capitalize on attractive prices. Simone Santiago, a managing director at Morgan Stanley Investment Management, highlighted that municipal bonds are currently the most affordable they have been in about a decade. There is a prevailing concern among investors that if they do not engage in the market at this juncture, they might miss out on the opportunity to purchase municipal bonds at these compelling levels.

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As of November 1, trading volume reached approximately 87,400, surpassing the previous year's high of around 84,000, according to data from the Municipal Securities Rulemaking Board (MSRB). Since the beginning of the month, volumes have consistently ranged between 70,000 and 80,000. The year-to-date average daily trading volume for municipal bonds is about 51,000, close to exceeding the full-year average volume for 2022, as per MSRB data.

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The surge in trading activity is linked to rising yields, with municipal bond yields reaching some of their highest levels in over a decade this year. Despite challenges faced by the market, investors have been enticed to buy. The ten-year benchmark, top-rated municipal bond yields surpassed 3.6% at the end of October, prompting increased trading in early November. Investors found the absolute yield levels appealing, and softer economic data led to a rally, causing the ten-year yield to drop by over 50 basis points to 3.1% as of Thursday.

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The market's heightened trading volumes since October can also be attributed to tax-loss harvesting, a strategy where investors sell depreciated securities and reinvest in similar, higher-yielding bonds, according to a report by Western Asset Management Company.

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Despite the increased trading activity, JJ Warren, a municipal-bond trader at Stifel Nicolaus & Co Inc., cautioned against misinterpreting the situation. He noted that, until last week, the market was on track for its second consecutive year of declines. He highlighted the market's substantial activity during periods of uncertainty, such as the onset of the COVID-19 pandemic.

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The recent slowdown in U.S. inflation suggests that the Federal Reserve might be approaching the conclusion of its interest-rate hiking campaign. This potential development could lower borrowing costs for municipal bond issuers, subsequently boosting bond sales.

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Simone Santiago from Morgan Stanley Investment Management expressed optimism, stating that if the Fed begins to cut rates, there will likely be more active buyers in the municipal bond space, as investors shift from money markets to traditional munis, foreseeing an increase in trade volume over time.