Banner Performance, But Far from a Straight Line
The municipal bond market, as measured by the S&P National AMT-Free Municipal Bond Index, finished 2023 posting its strongest quarter in 14 years. Its 2023 annual return of 6.24% was its best full-year performance since 2019. While this was good news for many market participants, the path to get there was far from linear; 2023 presented many challenges for most fixed income asset classes, with central bank policy at the core. Municipal bond indices proved resilient throughout the volatility, with favorable technicals and strong fundamentals driving performance. As a new year begins, municipal bond indices may continue to be positioned to provide opportunities for 2024, both on a broad basis as well as across the curve.
Full Circle: How Did We Get Here?
The municipal bond market spent much of 2023 weathering the storm of interest rate volatility, as the U.S. Federal Reserve continued the most aggressive rate hiking cycle seen in over 40 years. While the year began with optimism, performance across the municipal bond suite struggled through mid-year 2023 as the Fed raised rates for the 11th time in 16 months to 5.25-5.50%, before pausing in September. The 10-year U.S. Treasury bond yield reached its peak in October, surpassing 5% for the first time in 16 years, at which time the S&P National AMT-Free Municipal Bond Index was down 2.13% YTD.
The rest of the fourth quarter would see the rate narrative change sharply, as falling inflation and weaker-than-expected economic data coupled with the Fed pause increased market expectations for rate cuts in Q1 2024. The 10-year U.S. Treasury yield fell from its high and came full circle to end the year largely where it began, near 4%. Munis rallied in sympathy with Treasuries and the S&P National AMT-Free Municipal Bond Index posted a quarterly gain of 7.29%, its strongest single quarter since Q3 2009.
