MSRB Year-End Report Shows Rising Rates, Substantial Outflows Contributed to Historic Trading Levels

2022 Municipal Market Year in Review

The municipal bond market notched a record number of trades in 2022, coincident with record outflows and accelerated increases in the effective federal funds rate, according to a report released today by the Municipal Securities Rulemaking Board, or MSRB. The number of trades reached 12.69 million in the municipal bond market, breaking the record previously set in 2008 by 17%. The 2022 trading levels were also 66% higher than 2021.

“This extraordinary increase in trade count supports previous MSRB research that showed trade count rises significantly during periods of increasing interest rates,” according to the report.

The relentless outflows from the municipal bond market last year also contributed to the increase in institutional trading, typically denoted by trading blocks of $1 million or more bonds. The par amount of institutional-sized trades sold increased 125% in 2022 to $599 billion from $266 billion in 2021. The overall number of trades also almost doubled to roughly 147,000 in 2022 from roughly 75,000 in 2021.

The number of trades with block sizes smaller than $100,000, which typically denotes individual trading, increased 55% in 2022 from 2021. This trend is also reflected in MSRB research focused on alternative trading systems, or ATS, which focus on handling block trades of $25,000 or less. November and December recorded the highest amount of inter-dealer trades over ATSs than previously recorded.

The MSRB points out on multiple occasions the effect that rising interest rates had on municipal bond liquidity and returns.There was a dramatic increase in tax-exempt municipal benchmarks and Treasury bond yields, according to the chart below. Despite the dramatic increase in rates, the 10-year tax-exempt rate peaked at a level last seen in 2011:
 
Outflows and rising interest rates had a negative impact on municipal bond fund returns, but municipal exchange traded funds seemed to buck the trend. Inflows into tax-exempt ETFs were $29 billion, 41% higher than the previous record set in 2021. Trading volume for ETFs was up 330% compared with 2021.

“Some market participants have told the MSRB that some of the inflows into ETFs were a result of investors redeeming their mutual funds to realize losses for tax purposes and simultaneously buying municipal bond ETFs to replace the mutual funds,” according to the MSRB report.