Municipal Market Update: July

Municipal Market Update: July

Western Asset examines recent trends in the muni bond market and provides its outlook about conditions ahead.


Performance

  • With low yield volatility, and a strong fundamental backdrop, municipal bond prices were generally lower, but income returns pushed totals returns toward a modest positive position by month-end.
  • The Bloomberg Barclays Municipal Bond Index posted a positive total return of +0.24% in July, outperforming the Bloomberg Barclays U.S. Aggregate Bond Index (the benchmark for the taxable market), which returned +0.02%.
  • For the year-to-date period, the muni index was basically flat; down -0.01%, but again better than its taxable counterpart, which was down -1.59%.
  • Short and intermediate bonds generally outperformed longer bonds in July and lower credit quality issues generally beat higher-rated securities.
  • High yield municipal bonds outperformed investment grade bonds as the Bloomberg Barclays High Yield Municipal Index posted a return of +0.35% in July and was up +4.03% for the year.

 

 

Revenue bonds outperformed G.O. bonds for the 12-month period, but lagged slightly in the other periods shown

Revenue bonds outperformed G.O. bonds for the YTD and 12 month periods

Source: Bloomberg Barclays, as of 7/31/18. Past performance is no guarantee of future results.  An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges. For illustrative purposes only and does not represent the performance of any specific investment product.

 

Technicals

  • Demand, as measured by flows into open end municipal bond mutual funds remains steady.
  • Muni new issuance in July totaled $27 billion, down modestly from June’s $33 billion figure.
  • Year-to-date, gross issuance was a little north $190 billion, down about 15% compared with the first seven months of 2017.
  • We believe the dynamics between supply and demand for munis will remain favorable in the short term as bond redemptions are anticipated to remain high in August, and supply is likely to remain restrained.

 

Muni issuance: 2018 vs. 2017

Muni issuance: 2017 YTD vs. 2016 YTD

Source: Bloomberg Barclays, as of 7/31/18.

 

Monthly net new cash flows into long-term muni funds and ETFs

 

Monthly net new cash flows into long-term muni funds and ETFs

Source: Source: Investment Company Institute, Washington DC, as of 8/08/18. July flows are estimated as of the week ending 7/25/18. 

 

Valuation

  • Short and intermediate muni bonds outperformed the long end in July with yield ratios of muni bonds inside of 10 years richening more relative to U.S. Treasuries than longer-dated issues.
  • The 10-year AAA muni to US Treasury ratio is 84%, and on the long end is 99%. These ratios are calculated by dividing the respective muni yield by the respective US Treasury yield.

Yield Curve Comparison: BBB Muni Revenue, AAA Muni & US Treasury

 

Yield Curve Comparison: BBB Muni Revenue, AAA Muni & US Treasury

Source: Bloomberg Barclays, as of 7/31/18. Past performance is no guarantee of future results.  For illustrative purposes only and does not represent the performance of any specific investment product.

 

Muni/Treasury Ratios and Taxable Equivalent Yields 

 

 Muni YieldUST yieldsMuni/Treasury RatioTaxable Equivalent Yield
AAA    
1 year1.47%2.41%60.95%2.33%
3 year1.76%2.77%63.48%2.79%
5 year1.97%2.85%69.07%3.12%
10 year2.49%2.96%84.03%3.95%
30 year3.06%3.08%99.38%4.86%
BBB Revenue    
1 year1.85%2.41%76.90%2.94%
3 year2.25%2.77%81.31%3.57%
5 year2.48%2.85%87.08%3.94%
10 year3.16%2.96%106.71%5.01%
30 year4.09%3.08%132.67%6.49%

Source: Bloomberg Barclays, as of 7/31/18. Past performance is no guarantee of future results.  For illustrative purposes only and does not represent the performance of any specific investment product.  Taxable Equivalent Yield (TEY) is based on 37% top tax bracket. An investor may be subject to the federal Alternative Minimum Tax, and state and local taxes may apply. Capital gains, if any, are fully taxable.

Outlook

  • Our short-term outlook is unchanged; we believe valuations will be driven in the short term mostly by the balance between supply and demand, as we anticipate fundamentals to remain solid.
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Outperformance does not imply positive results.

A credit rating is a measure of an issuer’s ability to repay interest and principal in a timely manner. The credit ratings provided by Standard and Poor’s, Moody’s Investors Service and/or Fitch Ratings, Ltd. typically range from AAA (highest) to D (lowest). Please see www.standardandpoors.com, www.moodys.com, or www.fitchratings.com for details.

Yields and dividends represent past performance and there is no guarantee they will continue to be paid.

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.

High yield bonds are subject to increased risk of default and greater volatility due to the lower credit quality of the issues.

U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.