Municipal Market Update: January

Municipal Market Update: January

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


Performance

  • The Bloomberg Barclays Municipal Bond Index posted a negative total return of -1.18% in January, slightly behind the Bloomberg Barclays U.S. Aggregate Bond Index (the benchmark for the taxable market), which returned -1.15%. 
  • However, munis outpaced the Bloomberg Barclays U.S Treasury Index, which returned -1.36%. The Bloomberg Barclays High Yield Municipal Index posted a return of -0.94%.
  • Two significant factors led to the markets poor performance. Positive economic data coupled with inflation sentiment turning more bearish was reflected in higher yields across the U.S.Treasury (UST) curve, and the municipal sector followed along.
  • Away from weakness in the UST market spilling into the muni market, January’s negative performance can also be linked to events that unfolded in the municipal market during the month of December when investors spent-down considerable amounts of cash to absorb a massive amount of supply of new debt that rushed into the market as a result of tax reform.

Revenue bonds underperformed G.O. bonds in January, but outperformed over the previous 12 months

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

Source: Bloomberg Barclays, as of 1/31/18. 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

  • Muni issuance in January 2018 totaled $20.7 billion, down 68% from $64.1 billioin December 2017 and down almost 43% from $36 billioin in January 2017. 
  • Over the previous 12 months total muni issuance was $423.6 billion, down 7.1% from $456.1 billion for the same period a year ago.
  • Cash flows into long-term municipal mutual funds and ETFs were estimated to be +$10.5 billion in January after dipping slightly in December.
  • Over the previous twelve months cash flows into long-term municipal mutual funds and ETFs were estimated  at $37.6 billion.

 

Muni issuance: 2017 vs. 2016

 

Muni issuance: 2017 YTD vs. 2016 YTD

Source: Bloomberg Barclays, as of 1/31/18.

 

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 2/07/18. October flows are estimated as of the week ending 1/31/18. 

 

Valuation

  • During January, the muni yield curve steepened as 10yr and 30yr high grade municipal yields rose, while yields for shorter maturity munis were unchanged to slightly lower.
  • The 10-year AAA muni to US Treasury ratio is near 88%, and on the long end is 101%.

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 1/31/18. 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 year1.41%1.88%75.04%2.24%
3 year1.65%2.28%72.22%2.62%
5 year1.84%2.51%73.11%2.92%
10 year2.38%2.71%87.84%3.77%
30 year2.96%2.93%100.99%4.70%
BBB Revenue    
1 year1.93%1.88%102.74%3.07%
3 year2.37%2.28%104.00%3.77%
5 year2.62%2.51%104.18%4.16%
10 year3.30%2.71%121.84%5.23%
30 year4.20%2.93%143.08%6.67%

Source: Bloomberg Barclays, as of 1/31/18. 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.

 

Outlook

  • We are constructive on the municipal market so long as supply stays manageable, cash flows into open end mutual funds are positive, and fundamentals remain steady.
  • We continue to focus in the revenue bond sectors where there is a yield advantage over GOs, and where credit fundamentals are strong.
  • Our view is that the recent sell-off may be establishing a good entry point into the market, especially if UST yields stabilize at current levels.

A quick update on infrastructure:

  • There was a document leaked during the month, supposedly outlining forthcoming infrastructure policy proposals.
  • The relevant factors for municipal bond investors include an expansion of the Private Activity Bond (PAB) program and despite the ink being barely dry of tax reform, PAB advance refunding will come back.
  • Should this infrastructure package find support and get passed, there would be an increase in PAB supply, but we still expect infrastructure proposals to meet with a variety challenges, especially finding capital to fund projects. That aside, any increase in PAB issuance is likely to be rather small during 2018.
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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.