Municipal Market Update: October

Municipal Market Update: October

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


Performance

  • Total returns for municipal bonds during October were modestly positive.
  • The Bloomberg Barclays Municipal Bond Index advanced +0.24% in October, ahead of a +0.06% gain in the Bloomberg Barclays U.S. Aggregate Bond Index. 
  • For the year-to-date (YTD) period, the Bloomberg Barclays Municipal Bond Index generated a +4.92% total return compared with +3.20% for the Bloomberg Barclays U.S. Aggregate Bond Index.
  • During October, long and intermediate maturities outperformed the short end as the municipal yield curve flattened. 
  • Meanwhile, triple-B and single-A securities outperformed double and triple-A bonds, but the +0.27% monthly gain for the muni high yield index was bascially in line with the +0.24% gain in the investment grade index. For the YTD period, muni high yield returned +8.01%.
  • A stable domestic economic backdrop, coupled with modest inflation, is fostering a climate where muni credit spreads remain tight and spread dispersions within and across various sectors remains low. 

Revenue bonds outperformed G.O. bonds for all periods shown below

 

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

Source: Bloomberg Barclays, as of 10/31/17. 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

  • A favorable balance between supply and demand is also contributing to a steady backdrop for municipal investing. 
  • New issue supply is down roughly 18% compared to last year’s pace and muted supply is being met with positive mutual fund cash flows. 
  • Year to date cash flows into long-term mutual funds and ETFs now stands above $30 billion and has been net positive each month this year.

Muni issuance: 2017 YTD vs. 2016 YTD

 

Muni issuance: 2017 YTD vs. 2016 YTD

Source: Bloomberg Barclays, as of 10/31/17.

 

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 11/01/17. October flows are estimated as of the week ending 10/25/17. 

 

Valuation

  • During October, the muni yield curve flattened and yield ratios were stable and remained tight across most maturities.
  • The 10-year AAA muni to US Treasury ratio is currently at 85.4%, and on the long end is slightly above 100%.

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 10/31/17. 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 year0.99%1.42%69.96%1.76%
3 year1.21%1.73%70.12%2.14%
5 year1.45%2.02%72.11%2.57%
10 year2.03%2.38%85.40%3.59%
30 year2.89%2.88%100.19%5.10%
BBB Revenue    
1 year1.57%1.42%110.36%2.77%
3 year1.98%1.73%114.69%3.50%
5 year2.26%2.02%112.19%4.00%
10 year3.01%2.38%126.54%5.32%
30 year3.99%2.88%138.63%7.05%

Source: Bloomberg Barclays, as of 10/31/17. 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 43.4% top tax bracket.

 

Outlook

  • We expect a flatter yield curve and will look for opportunities in 10-20 year maturities in our intermediate and long duration strategies. 
  • Duration exposure is close to benchmark, except for short duration strategies where we are short rate risk.
  • In terms of credit quality, we continue to look for opportunities in lower investment-grade securities and below-investment-grade markets, but also continue to have a up-in-quality bias given the current low credit spread dispersions and more broadly tight credit spreads.

Tax reform

  • Individual and corporate tax reform is front and center as Congress released details to their Tax reform proposals. 
  • As we expected the plan is mostly positive for municipal bond investors because the proposal does not strip municipal bonds of their tax-exemption and other provisions may limit the amount of future municipal debt that can issued for certain types of municipal issuers, such as refunding activity or debt floated to build sports stadiums. 

Puerto Rico

  • More than half the territory remains without basic services such as electricity.
  • It is clear to us that island officials do not have the tools necessary to repair or rebuild their infrastructure.
  • Bond prices for the island’s debt are down substantially. Junior and senior Cofina debt are trading at 14 cents, and 43 cents on the dollar respectively, and GO debt is trading around 27cents.
  • Western Asset strategies currently have zero exposure to Puerto Rico debt.
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IMPORTANT INFORMATION: All investments involve risk, including loss of principal. 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.

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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.