After tumultuous first half, muni performance still rate driven

BlackRock’s Head of Municipals Peter Hayes sits down with The Bond Buyer’s Lynne Funk and lays out the muni landscape for the rest of the year, highlighting opportunities for the asset class after the severe volatility so far in 2022.

Lynne Funk: (00:11)
Hi everyone. Thank you for joining today's Bond Buyer Leaders session. I'm Lynne Funk, executive editor at the Bond Buyer, and I'm delighted to welcome Peter Hayes, head of municipals at BlackRock, to join us today, to give us insights into where the muni market stands, after what has been quite a volatile 2022. Welcome Peter. Thanks for joining us.

Peter Hayes: (00:34)
Thank you for having me; really great to be here.

Lynne Funk: (00:37)
Great. So as I assume that most folks on this session know, the municipals had a heck of a first half, seen losses not felt since the eighties, record or near record outflows from muni mutual funds. And while the past month has seen some stability in some positive returns, we know the Fed moves yesterday, and today's quite ugly GDP numbers are leading to a louder recession drum beat. So we'll, we'll get to the Fed in a bit, but Peter, why don't we just start with an overview of how this market in 2022, nearly seven months in, has been rough to say the least. Was the market caught off guard perhaps after nearly two years of exceptionally low rates and low volatility?

Peter Hayes: (01:21)
Yeah, it's actually a really good point and caught off guard is sort of an interesting, I don't think anybody likes to ever admit they were caught off guard, but you know, there were certainly some telltale signs. One is that we were seeing higher inflationary data from the tremendous fiscal stimulus and aggressive monetary policy to keep the U.S. Economy afloat through COVID. In terms of the muni market, we had seen enormous inflows in 2021. I think it was probably the second highest ever on record for a year into mutual fund municipal mutual funds. There was a little bit of chasing performance, but what that did, two things. One rates were very low at an absolute basis, whether you look at fixed income or tax-exempt rates. And the other is that our ratio sort of our relative value numbers were also very, we were very expensive.

Peter Hayes: (02:10)
And so there were a lot of telltale signs, but I think that what really took place here is that for the first time, in a long time, maybe perhaps since the late nineties, we've seen kind of a true fair market, and we didn't go up hundreds and hundreds of basis points like we have in the past. But think about the level we were coming from. So when rates go from five and a half to 6%, you know, that's one thing. When they go from one and a half to 2%, that's another, you see bigger negative returns because of that. So what took place then is you sort of had this broad fixed income aversion. The beginning of the year, there was a realization that Fed was gonna be more aggressive. They were behind the curve. Inflation data was much higher than many people expected.

Peter Hayes: (02:56)
Munis, as I mentioned were very expensive. So that seasonal effect that we usually look for in January never really materialized. And we got into this prolonged prolonged six months bond bear market, that many people haven't seen for some period of time. If I think back and many times, if the 10 year treasury was at one and a half, the rhetoric was, well, if I'll be a buyer, if the 10 year gets to 175 or 180 or 185, right, there was always that backstop buyer. And here, there wasn't. I think people just disappeared not knowing how progressive the Fed was going to be and what the impact on rates was going to be. So we began to see these negative returns with negative returns came outflows across fixed income. And I think that had a sort of a secondary and knock on effect. And that was, it created very poor liquidity in the market dealers, et cetera, just pulled back.

Peter Hayes: (03:49)
They really didn't know where that backstop was going to come from. They were waiting for flows to stabilize, which they really didn't at least in the muni market until very recently over the last month or so. So you had this kind of double whammy. And as a result, I think absolute returns were exaggerated. At one point, the index was down over 10%. We haven't seen anything like that in a, in a long, long time and muni investors, they're not used to seeing those type of returns in their portfolio. We've had pockets of it in 2020 with the COVID sell off and shut down, but even flows then bounced back quickly, returns bounced back quickly. And this time that really didn't happen. So the returns went negative, stayed negative for a long period of time. I think you saw people do a lot of tax loss swapping, and they sort of sat in other vehicles, but in general flows were down and they were down big and liquidity was pulled away on the Street. So we were kind of looking for a footing, but it was a double whammy of rates and illiquidity that really created this, scenario as you called it, you know, a heck of a six months, which that's sort of being kind, but, certainly it's been, it was a very difficult six months that most people aren't used to, but I think that was really the backdrop in, in terms of what's happened.

Lynne Funk: (05:08)
Right? So actually this works well. You set me up quite well. Quite a few liquidity questions and demand component questions to kind of delve into here. And well II guess I'd like to start with funds flows, you know, as of yesterday ICI pegs the number at $88.9 billion of outflows for 2022, you know, Lipper has that a little bit lower $47.8 billion, well, quite a bit lower, but they haven't recorded today. So has the market become too reliant on mutual funds?

Peter Hayes: (05:46)
It's a really interesting question because when you look at growth, right? So for those who've been in the market like myself for a long period of time, the municipal market was always a buy and hold individual bond type of market. Individual investors bought a bond. They literally, way back when clipped a coupon and took it to the bank ,and they got a cash flow. And then obviously the cash flows were, were kind of automatic, but that was the nature of the bond buying. They liked the permanence and definition of a bond. They knew when they were going to get there, if they were right on credit, they were going to get par value back for that particular bond. And then the market sort of changed a bit in the nineties. I think the growth of mutual funds, the growth of closed end funds.

Peter Hayes: (06:27)
People had different options. Largely I would say insurance took off, right? So a AAA model, when insurers backing the market, et cetera. And then in with the financial crisis and the demise of the insurers, picking individual bonds became much more difficult. You really had to understand what the underlying credit was. I think a lot of the firms where these advisors worked and bought individual bonds for their clients also had an aversion to doing that. They sort of realized the risks that their advisors were buying, buying bonds, that they really didn't know anything about the underlying credits. So you began to see what I would call the outsourcing of a lot of the municipal fixed income investments. And they did it in different forms. They did it in closed end funds. They did in mutual funds. They did it in SMAs. You've seen tremendous growth in SMAs.

Peter Hayes: (07:19)
Mm-hmm. Over the last 10 or 15 years, and everybody sort of expressed their investment or the way they wanted to invest a little bit differently depending on their style, depending on their risk profile, et cetera. So it, it's hard to say that we've become too dependent on mutual funds. But what did take place at the same time was a lot of the regulations that were put in place financial post-financial crisis, limited to the risks the banks could take to provide liquidity. And as a result, they would kind of look at those flows. And I alluded to this early this year, when they saw flows constantly out, they basically just pulled away from the market largely and said, we're waiting for flows to stabilize. And that's kind of what took place in this year. So I could see that combination of the, you know, committing less capital because of the charge they get on regulatory capital, et cetera.

Peter Hayes: (08:18)
And this kind of outsourcing notion, I think could lead you to believe that there's been a bit of a dependency on that until we see some of the risk taking really come back. And it is, it's a really interesting question. One we're thinking about, and I think also as implications for the market. You mentioned 88 billion out, which is more than we saw. I think last year we were what, 84, 85 billion in? Something like that. Yeah. So in six months we've already seen more, more out than we've seen come in. And I think many people think those flows are going to back. We'll see. But obviously it's going to be dependent on what mutual fund flows do as to the strength of the market, I think, going forward. So you could make an argument that perhaps that notion is partially correct. And I think there may be a little bit of a pivot here as well.

Lynne Funk: (09:09)
So would you, you mentioned another component of muni market. Dealer carry. You know, less inventory. How is that affecting the market, particularly in times of volatility? Back in March, 2020, they exited. After the great recession, there was quite a bit of regulatory requirements put on them. But how much has dealer inventories affected the muni market, or the lack of carry

Peter Hayes: (09:44)
So it, it definitely has, you know, there's, there's another sort of component into that. And, and one is the tax law changes that took effect in 2017 lowered the corporate rate. Oftentimes you would see, and you saw this in, you probably saw it post financial crisis. You saw it to some degree in the Meredith Whitney sell off, a bit in the taper tantrum that when ratios got cheap and the muni muni traditional tax muni market was attractive relative to investment grade corporates or other part of the fixed income spectrum. We'd have these crossover taxable buyers come in. So in combination with the dealers, you had sufficient liquidity. So the market could operate fairly efficiently. Some people would argue the main market isn't particularly efficient. It's a little bit of a feast or famine market, right? It's when things are bad, you could just buy bonds at any price.

Peter Hayes: (10:36)
And when things are good, like they are now, it's hard to find a bond. It's kind of what, you know, where's the happy medium. But I think back then, at least there was a little bit more stability when munis were effectively backstopped at a certain ratio, because we had the crossover buyer and because the crossover buyer was there, dealers were willing to take a little bit of risk position, not only for mutual funds, asset managers, traditional buyers, but also for crossover buyers, they would kind of be talking to their taxable counterparts in institutional sales and saying, you know what, where are your client's care, whether it be bank portfolios, insurance companies, et cetera. And then when that corporate rate went down, we really lost a lot of that crossover buyer. And as a result, I think the market, is a bit more dependent on some of those flows.

Peter Hayes: (11:27)
And as a result, you have seen less risk taking by dealers. So it ebbs and flows, and the other thing, it's a little concerning Lynne, to think about, and I go back quite ways, but I think about, you know, Solomon and first Boston, and some of these firms that have exited, muni's kind of over the years for various reasons. And in many cases, it's, because they're coming off a year of substantial losses and banks or dealers, they want to re-underwrite how they use capital and reallocate that to places where they can ultimately get higher margins. So I wonder if that's gonna be another offshoot of this. Obviously dealers have had a very, very difficult six months of the year. I'd be surprised if any have positive P and L given what's happened. And that might cause some sort of reassess the risk taking within munis as well. So I think there's more to come. I don't think the story's over yet, but yeah, it, it is clear that I would say inventories, risk taking by dealers, and thus liquidity is definitely not what it was, you know, certainly prior to the tax change and then even prior to the financial crisis.

Lynne Funk: (12:35)
Can you talk just to go back for a second, actually, thank you for that. This is very interesting. I think I've been sort of hearing peripherally, some folks in the industry just, concern about it, concerned about where the dealers, fit in this. But can we go back to just for a second on when we talked about the shifting retail, you know, you mentioned SMAs, but what about ETFs, you know, have you, where do ETFs play a role in your cause they've been in positive inflow territory, most of this year, relative to the mutual fund, where do they fit? What does it mean for the market?

Peter Hayes: (13:12)
Yeah. I mean, they certainly fit a lot more than they ever used to. When you look at flows this year, they certainly enjoyed some pretty substantial inflows even while the rest of the industry was going out. And there's a couple reasons for that one. I think if you go back, even before this year, there was sort of growth in ETFs because the, the nature of advisors and clients are changing, right. We've seen, as I mentioned, a move away from the advisor, who's been buying individual bonds for the clients and doing it forever. A lot of those have retired or their firms have changed, or they've changed firms. And we've seen a lot of money move to family offices and RIAs who registered investment advisor channel. And they rely heavily on models and models use ETFs, whether it be in equities or income or munis, et cetera, they're just easier to execute their lower cost.

Peter Hayes: (14:08)
Right. We have MUB, which is the iShares, um, national ETF and the fees on that, are seven basis points. So, you know, the industry obviously is moving to this kind of low-fee type of structure. So it has appeal in that aspect as well. So they've been utilized more over the last several years regardless, and you can certainly argue active management versus passive management. Can you really replicate? I would argue it's very difficult to replicate fixed income, passive management and equities. You could sort of take an index and you can perfectly replicate. In fixed income it becomes harder. Even in places like taxable high yield and, and corporates, et cetera, it's harder. And then you take an asset class like munis. It's very hard. So they do a good job of minimizing tracking error, but it's not a perfect match.

Peter Hayes: (15:01)
So, you know, there's an argument to be made about passive versus active and the value of active management and being opportunistic and nimble and so forth. You can't have in a passive vehicle, but nonetheless they've certainly, served a good place. I mean, one of the things that we talk about to our clients using them as in different elements for either liquidity or different part of the market, et cetera. You know, interestingly, this year we've seen a pretty good growth in our I bond suite, which is sort of that permanence and definition. So it's not an individual bond, but it has a finite maturity date where again, if they're right on credit, they'll get their money back. So we've seen growth in that. And then the bigger growth this year, uh, that we've really seen in ETFs is because of the tax loss harvesting.

Peter Hayes: (15:50)
I think there would, they were used as a placeholder when returns began to get very negative. A lot of clients used their municipal mutual fund investments to harvest tax losses that they could either offset gains or use and carry forward at some point in time. And the easy placeholder, because the ease of execution is the ETF. So a lot of money went in there. Now, the question, the bigger question is will that money stay there or will it move back into mutual funds or will it move into SMAs, et cetera. Some people would argue that there's probably is similar issue or thesis within cash as well. But I think it's more pronounced than ETFs. People still wanted the tax-exempt income. So they moved from a mutual fund into an ETF in some cases, a long category with longer duration into intermediate, et cetera, but that's been the big driver this year and going forward, will that money move back out or will it stay there? But they've, they have clearly become a force in the market. That's not going away at any time soon, particularly with the low fee. People also talk about the transparency. I'm not sure individual investors care as much about the transparency on the ETF, so you can kind of see the bonds and what's going in to create shares. I think it's really about the fees and ease of execution, but they're, they're here to stay and those are the two reasons they've grown over the years.

Lynne Funk: (17:21)
Okay. Shifting away from tax-exempt into taxables. The 50% drop year over year in taxables. We just saw preliminary numbers from that's showing July issuances down. 70% refund is down 76.

Lynne Funk: (17:56)
So we were talking about taxables. The big precipitous drop. And they were for a rather large part of the market over, you know, since the latter half of 19. They're dragging down issuance levels as well. Really the tax advance refunding losses. Will we see perhaps a return to more taxable issuance once rates stabilize? I I mean, it's grown a bit, a little bit more in recent, in recent weeks, but

Peter Hayes: (18:30)
Yeah.

Lynne Funk: (18:30)
Where do they fit?

Peter Hayes: (18:32)
So I would say the short answer is no. Issuers got a bit lucky post 2017. Remember they eliminated advanced for advance refunding. So you couldn't use a tax-exempt issue to advance for refunding an outstanding tax-exempt issue. Right? So whatever reason it was a revenue raiser. So they went ahead and did that in the meantime, treasury rates moved very, very low. So absolute treasury rates moved below where a lot of the net interest costs was for outstanding issuers. So they were able to retire an outstanding tax exempt issue, issue, a taxable bond and taxable bonds spread off of treasuries, you know, depending on, high quality plus 30 plus 40 less quality plus 110, 120 over whatever the 10 year, 30 year treasury, whatever the maturity is. So nonetheless with great taxable rates and treasury rates so low, they were able to do that and still save money.

Peter Hayes: (19:29)
And it was just an anomaly in the market. The fact that treasury rates move so low. Now that treasury rates have moved back up, there's a lot less of those opportunities that are out there. So we don't see that anytime soon. We also often get asked, do you think advance refundings will come back in the market? And my shorter answer is no. Just because again, it's a it's source of revenue. When you think about what's gone on or the need for revenue, it would be a tough one to come back barring some overhaul of the tax bill generally, or a larger tax bill. The interesting part about taxable munis is that since Build America bonds that started in 29, 2 09, right, with the American recovery and reinvestment act, there's been a greater recognition for municipal credit, more broadly, what it is.

Peter Hayes: (20:19)
They do things like infrastructure, it's high quality, low default rates with high recovery rates. So the audience for taxable taxable municipals has grown a lot. There's a lot of demand and you could in theory bring a lot more issuance, but I think again, it's a function cost, particularly interest rates having gone up. So I think you'll see more of it this year. I think it's about 19% and you're right at peak debt about one third. And the interesting part about that peak with one third is that it actually made less tax bonds available to the traditional high net worth investor, though. It sort of was an additional uplift to performance of the muni market for a period of time. And now we're giving some of that back in terms of, you know, there's just, there's more issuance, even though I would argue this year is a fairly light issuance year, but volatility in the market that is to be expected. So we don't see it really coming back anytime soon. But we meet with folks in Washington and regulators and they talk about infrastructure and we say, use the taxable muni market. You've got a global audience. So, um, but in the meantime, I think it is going to continue to trend lower. I think this year it's probably in the 10 to 15% range, and I don't know if it moves, depends on what rates do. It may move a bit lower, but I certainly don't see it moving higher.

Lynne Funk: (21:40)
Yeah. It's interesting. You bring up the way that taxables, giving less demand for, or more demand for tax exempts. You know, I think that was kind of the argument when BABs came about, right, is that, it really helped the overall market, helped the smaller issuers, and tax-exempt space because the larger issues were tapping taxables. This actually is a good segue then. So, you know, when you say a new, broader audience, international investors, are you seeing that? Is there demand there and will that continue? You know, is that a new tool for issuers to tap?

Peter Hayes: (22:21)
They should be tapping it more than they are. There is a global audience. I mean, you're absolutely correct. The audience is not only in Asia, but it's also Europe. And again, I think there was just this, there was a bit of a learning curve on what the municipal market was really. There's no, there's a few municipal like markets globally away from the U.S., but the U.S. is pretty unique for a lot of features. So there was this kind of big learning curve for a lot of overseas investors in terms of the muni market. And over the last several years, they've gotten comfortable and there is demand and it does increase. Now it's dependent on a lot of things. It's depend. It just dependent on a lot of them hedge back the duration. So it's dependent on hedging costs. It's dependent on currency as well.

Peter Hayes: (23:07)
A lot of times they'll hedge back the currency risk as well. So it ebbs and flows a bit. There's also sort of a regulatory regime aspect to this. So how municipal taxable municipals are treated in Taiwan is different from South Korea and different from Japan, you know, particularly with regards to the insurance industry. So that has an impact on demand as well. And when rates were very low across the fixed income spectrum, taxable municipals offered a really good alternative for them to pick up some income, which is why demand had kind of increased. Now that investment grade corporate spreads have widened and other areas of fixed income are attractive. I think you're seeing probably a little less interest in taxable munis, but my guess is it's not going to go away. They also really like the infrastructure angle. Like they love the infrastructure angle of the U.S. taxable municipal market. So that's one that's not going to go away. So I don't know. I agree with you that issuers should be utilizing that more. They have in the sort of an untapped resource, but my guess that'll continue to grow. It'll just probably grow slowly over time.

(24:17)
So can you talk a little bit about another shifting gears here? Everyone's favorite or, or not favorite topic is, uh, ESG.

Peter Hayes: (24:30)
I was afraid you were going to ask that

Lynne Funk: (24:32)
How do you see it fitting into the muni market? So many issuers at this point say, you know, when are they going to see a cost savings? But I kind of flip the question and that is, when are they going to face a penalty if they're not part of this ESG wave. Peter Hayes: ( 24:52) So yeah, you're, you're clearly asking some hard and really good questions today, they really are. They're actually very good, very good questions. Because they're things that a lot of people aren't aware of or thinking about, and, you know, they might see it a high level, but with regard to ESG, when you think about ESG environmental, social governance, it sort of is the muni market, right? To some degree and people will say, oh, ESG are Munis. Well, the problem is that we really haven't defined specifically what that is, right? I mean, environmental, clean water and so forth is sort of easy social aspect with regards to healthcare and education is sort of easy, but the rest is, and even particularly the governance, the governance one is a really, really tricky one. So I think the market everybody's kind of talking about ESG you're right. Peter Hayes: ( 25:40) And it seems to, from people on the outside, fit well with the muni market, but when you kind of peel it back and look at it, the inside, the people that probably are less enamored of it are portfolio managers and traders. And not that they're not supportive of it. The problem is there's no real demand yet in the U.S. it's different overseas. We've seen a lot of demand in Europe, particularly from institutional clients like insurers, et cetera, they're getting pressure from their board. So that's a little bit different overseas, but in the U.S., it's still, and I would argue, this is probably true of fixed income, it's very developmental. We have a long way to go. We need definitionally to figure out what it means, how it fits into the portfolio. We need to figure out what data we need, where we're gonna get it from. Peter Hayes: ( 26:29) There are some data providers out there, and by the way, it's very expensive. So you know, all these things have to sort of develop over time. And then once they do, we have to see where the demand materializes, particularly with the bulk of the traditional tax exempt market, which means the high net worth investor. We see pockets of it in places like California and so forth, but we're not seeing widespread demand for ESG-related investments. And as a result, the market is not assigning of value. So for issuers and they say, oh, I'm gonna bring an ESG bond or green bond. There's really no apparent savings at this point in the market, because there's just no strong, sustainable demand base. Will it develop over time? Probably there'll probably be a differentiation in some credits, you know, particularly as you think about climate change for coastal cities and the impact there and what they need to do longer term, it likely will develop. Peter Hayes: ( 27:27) I think it's still a number of years away before we really see that. So I don't want to dismiss it. It's something that's, it's a good question on your part. It's something we should be thinking about. The other aspect is we need to standardize it a bit across the industry. You know, we may have a different definition and then some of our competitors, or even the dealer community, et cetera, and you can't have that. It's only going to confuse investors once that demand materialize, and it's going to make it much harder to assign the value to a bond based on, on that. So we need to get some consistency. I don't know if it's the SEC or MSRB, but some of the regulators probably need to lead that effort to make it consistent across the industry. And that's something, again, that's gonna take a little bit of time. We all kind of agree to disagree. It's developmental, it's evolving. In five years, my answer might be very different, but between here and there, I think it's really hard to tell. We have a long ways to go. Hopefully that answers the question appropriately. Lynne Funk: ( 28:33) No, absolutely. I think, you know, you kind of hit the nail on the head. You know, we did a survey last fall of the industry, and we got a pretty good diversity of viewpoints, but one of the ones was that we need a standardization and we need some sort of perhaps universal language, but nobody really wants to say who should do it or who should lead it, or how does that come? How do we come to some sort of consensus? And, you know, you mentioned the MSRB, but you know, they cannot actually regulate the issuers or put any sort sorts of standards out there. So it's a tough position for the market. I I think just from my observations, it's an interesting. Peter Hayes: ( 29:08) I think you're spot on. I completely agree. You're spot on. Interesting results on the survey too. So we'll see. It seems to crawl ahead and I, we first started talking about this several years ago. I'm not sure it's advanced the tremendous amount since then. So the pace of change is fairly slow, but it does continue to be developmental Lynne Funk: ( 29:32) As is most things in the muin market. We kinda are slow to adapt. Peter Hayes: ( 29:39) We don't like change Lynne Funk: ( 29:41) So let's talk about credit. Especially right now. My big question is, should there be any concerns about issuer credit, federal aid, once that dries up. we're looking closer at a potential recession. And those sort of big problems that were out there in the before times, pre COVID, you know, they're still there. Right? Sometimes I wonder, have we had sort of had rose colored glasses on as this federal aid has been pumping from direct aid through the Fed, through the system, where does issuer credit stand, coming out of all of this? Peter Hayes: ( 30:28) They they've certainly got a lot of uplift in a number of ways. And if, I think back to March and April of 2020, when the world seemed to be falling in and nobody thought that any issuer would survive, this we've certainly come a long way. I mean, it's almost been a complete 180. You look at tax receipts across the board sales tax, personal income tax, property taxes from housing have all done better. So the timing of the question is interesting because we're probably at the peak of the strength of fundamental credit and the muni market it's as good as it's been. I think now that's from a very high level. I don't want to extrapolate that across the whole market, but clearly it's as good as we've seen because of those tax collections. In many cases, a lot of that fiscal stimulus funds have not even been, been spent rainy day funds in many cases have, have increased and are there for a downturn. Peter Hayes: ( 31:25) So it will be interesting, particularly with the stimulus money, how some of that gets used, whether it helps to offset some of this weaker economic growth. We see, we did see GDP today. So I guess we can use the term recession. We've now seen two you negative quarters. I sort of don't believe we're in a recession. That's another story. Um, okay. But nonetheless, all this downturn will have an impact on municipal credit. So I think we've kind of peaked in terms of ratings valuations. We need to think about that going forward, but I think the big issue is going to be more about the bifurcation of credit that will occur in the market. Over the next couple years, we've seen profound changes from COVID in the way people work, the way they live, where they work, where they live, where they're moving to, et cetera, and including companies. Peter Hayes: ( 32:17) And I think all that has implications for certain sectors that can be positive and certain geographies that can be positive. I also think it has certain implications of being negative. Think about mass transportation, the MTA within New York and New York office space is being utilized at a rate of 40% of what it was pre COVID. And nobody's really taking mass transportation, ridership. I mean, it's increased a bit, but it still remains very, very low. And some of those entities didn't come into this with very strong financial pictures to begin with. So I think there's gonna be sort of a little bit of the have, and have nots, which means that fundamental credit research is going to be all that more important. And if we do go into a much weaker economic environment, there's clearly going to be some areas that suffer more than others, particularly some of these speculative, project finance areas, maybe some land or dirt deals, how long can this housing market sustain itself, or there's been some areas that are, I don't if it's fair to call it a bubble, it's not bubble in the definition of 2008 financial crisis, but nonetheless we've seen some pretty robust price appreciation. Peter Hayes: ( 33:28) That's going to be difficult to maintain, particularly with mortgage rates having doubled, right. So more to come. So I think, you talked about the rose colored glasses, when we haven't had any headlines and we don't get any headlines. People get complacent, I think now is not the time to get complacent. Now is the time to really begin looking at what's going to be impacted positively and what will be impacted negatively. Lynne Funk: ( 33:55) That makes sense. So let's actually take a turn here to maybe talk about some good things. Hopefully some good things. A lot of folks on the street expect the next six months next five months — Now it's almost August — to be a turnaround for the muni market. Where do you all at BlackRock see this shaking out, especially given the R word being thrown around? What are the bright spots coming down the pipeline? Peter Hayes: ( 34:35) So I think the bright spots, bright spots are one flows, they've at least stabilized. And I want to talk more about flows. If I forget at the end, remind me, you asked a question already about SMAs and ETFs, but there's some important implications that I want to talk about that also probably have implications for the strength of the market over the next five or six months. So just remind me, or I'll try to come back to that. Okay. But flows will be important to liquidity. So we've seen flow stabilized, liquidity's getting a little bit better. And as I mentioned, the negative absolute returns that we saw for the year, I think were very exaggerated because of the illiquidity in the market. So you're gonna get some of that back. The income level is higher, right? Just by nature yields are higher. Peter Hayes: ( 35:24) So your carry component of your return is higher, which is beneficial. Your probability of loss, that goes down, because of that, when your income goes up, and if rates were to go back up, your probability of loss, your incidence of loss also goes down very low, which is good news as well. There's still, we're still a little bit in the seasonal effect, although that's been greatly dampen this year as it was in January, even in June, July so far it's been, I would call it somewhat dampen. You know, money's been going as we talked into ETFs and other places. So I think the demand component's gonna materialize a little bit, because simply if you have a dollar to put to work, you can now use that dollar, get more income and take less risk both in terms of credit risk and duration risks. Peter Hayes: ( 36:12) So I think that's good news for investors. And then the other is that we're clearly closer to the end of the Fed tightening than we are at the beginning. So there's a lot more certainty around what will happen. I do think, you know, you have a couple months here between the next fed meeting, so we'll have to see what transpires you typically have a week seasonal period at the end of the year. I think that issuance might actually increase as the market stabilizes. A lot of issuers were gun shy and just kind of stayed away from issuing and some of the volatility that we saw in the market. So I do think that there's better days ahead. We're going to get back some of that performance. So are we going get it all back in the next five months? I'd like to say yes, but that's unrealistic. Peter Hayes: ( 36:56) I don't think, but it's a good entry point for people who may be sitting in cash and waiting for an opportunity, even though we've seen the last six, seven trading sessions, we've actually seen some pretty good strength in the market. I do think it remains to be a pretty good entry point simply because of that, you can get more income and take less risk at this current juncture. So that's kind of how we're thinking about it. I would say high yield, I remain a little bit cautious on high yield, just because it may be impacted by slower U.S. Economic growth. So we tend to be up in quality, even though IG has probably performed better and tightened down over the last few sessions. I still like it up in quality trade here for portfolios. Lynne Funk: ( 37:41) So do you want to go back to your further thoughts on funds? You mentioned Lynne Funk: ( 37:49) You know, one of the things I do want say, II apologize to whoever told me this, I forget, but in past recessions, outflows have come along with that. So I guess maybe go ahead and, you know, tell me what you were thinking in terms of SMAs and, and we can talk. Peter Hayes: ( 38:07) So we were talking earlier about outflows and this year of 88 billion out. And when investors look at their returns, they look at very negative returns for year to date for one year. But even their three year returns are in many cases. Now this is probably maybe before today or yesterday, the last two sessions, but in many cases they were slightly negative were very, they were close to flat for three years. So if you're an investor and you say to yourself, wow, for the last three years I've been in this asset class that's done nothing. I haven't made any money at all on it. And because it's related to the volatility that's captured in a mutual fund, I wonder whether a lot of those mutual fund flows that we saw out are truly going to come back. And that has implications. As I mentioned for the performance over the next several months, I think a lot of people are betting that much of those flows will come back. Peter Hayes: ( 39:03) I don't see how that's possible. I would even be surprised if we saw a third of those flows come back. So I think it gets to the point where individual investors are sort of saying for three years, I've been sitting here. I don't know if I want to go back into a mutual fund. I may go back to the good old fashioned way, buy an individual bond. I'm right on credit. I mature at par. I don't have to deal with the volatility. And that's sort of the SMA question, right? That we're seeing even ETFs see a variability because they have they mark to market every day, et cetera. But with an individual bond, you buy a 10 year bond, you buy a 15 year bond, doesn't matter. You can sort of sleep on it, you get the cash flow on the income. And if you buy a good double A credit, your chances of default are, you know, so low that you're worth the risk. Peter Hayes: ( 39:53) So that, that's what I kind of wonder is if those flows don't come back, we see a move into SMAs buying individual bonds, which tend to buy more in the intermediate part of the curve. I think that has implications particularly for the long end of the muni market. So we're a little cautious, I would say that our thinking on that is evolving and fairly new. We'll have to watch trends. We're trying to get feedback from our partner firms and what their advisors and clients are doing, et cetera. But I think it's gonna be something to watch over the next couple of months. Lynne Funk: ( 40:24) OK. Well, great. Peter, is there anything else you want leave us with? Peter Hayes: ( 40:42) No, I think that's it. I mentioned, I would just say, I mentioned briefly that the next Fed meeting isn't until September 21st, right? So there's gonna be a lot of data between now and then. Chair Powell clearly said that it's going to be data dependent. And I remember in 2013, Bernanke gave a press conference and he told everybody it was going to be data dependent, and the market didn't believe him. They tried to extrapolate all kinds of volatility. So I think the point is we're gonna have to watch the data for the next two months to get indication of what the Fed might do. If they're going to do one more aggressive, two more aggressive hikes, where the terminal fed funds rate will end up. But in the meantime, I would say some of those periods of volatility are going to be good at buying opportunities the next two months. And that's what investors should really focus on. So I'll just leave with that very positive thought. Lynne Funk: ( 41:29) There we go. Fabulous. Peter Hayes. Thank you so much for joining us today. It was a great conversation, lots of really good insights. I hope we do keep in touch. Thank you very much. Peter Hayes: ( 41:44) That was awesome. Thank you so much for having me always enjoy. Great, great idea. This series. Lynne Funk: ( 41:48) Great. Thank you to the audience for listening. We really appreciate it. We didn't get to your questions, perhaps we might be able to get back to you on them. Thanks again, everybody for listening and I'm Lynne from the Bond Buyer, Peter Hayes. Thank you again. And we'll see you all soon. Hopefully. Peter Hayes: ( 42:02) Very welcome. Thanks everyone. Thanks Lynne Funk: ( 42:04) Like right.