It was the most volatile first half-year in the history of the muni market, yet the Bloomberg Barclays Municipal Index still returned 2.08% for the period following a strong second quarter.
AAA municipal yields were generally unchanged during the quiet, holiday-shortened week, and outperformed Treasuries, which moved higher in intermediate and long maturities. The Bloomberg Barclays Municipal Index returned 0.05%, while the high-yield muni index returned 0.11% for the week. Halfway through the year, the investment-grade muni index has returned 2.08% while the high-yield municipal index has returned -2.65%.
Fund Flows and Coupon/Principal Reinvestment Continue to Support Muni Technicals
During the week ending July 1, municipal mutual funds reported an eighth consecutive week of inflows at $1.1 billion, according to Lipper. Long-term funds recorded $426 million of inflows, high-yield funds recorded $119 million of inflows and intermediate funds recorded $9 million of outflows. Year-to-date (YTD) municipal fund net outflows now total $6.2 billion. In addition to fund inflows, the market has also been supported by seasonally high coupon and principal reinvestment demand, with over $40 billion of coupon and principal payments delivered in the last 30 days, according to Bloomberg.
The muni market recorded $6.1 billion of new-issue volume last week, down 37% from the prior week given the holiday-shortened week. Issuance of $203 billion YTD is 22% above last year’s pace, though tax-exempt supply is 2% lower than last year’s levels. We anticipate approximately $10.2 billion in new issuance next week, led by $1.2 billion short-term Los Angeles Tax and Revenue Anticipation Notes and $2.3 billion taxable and tax-exempt University of California transactions.
This Week in Munis: Halftime Report
Performance:
In what has been the most volatile first half of the year in the history of the municipal market following price declines of over 10% in March, the Bloomberg Barclays Municipal Index posted positive returns of 2.08% YTD through June 30 following a strong second quarter.
- Quality returns: Highest quality municipals were the best performers, with AAA and AA Indices returning 3.42% and 2.73%, respectively. A and BBB municipal indices underperformed, returning 1.36% and -2.05%, respectively.
- Sector returns: From a sector perspective, essential service water & sewer and electric utility sectors outperformed, returning 3.35% and 2.80%, respectively. Lease-backed and transportation sectors lagged the market, returning 0.15% and 1.04%, respectively.
- Curve returns: The belly of the municipal curve outperformed with the 10- and 15-year municipal indices returning 2.47% and 2.35%, respectively. The 1-Year Index and Long Municipal Bond Index (22+ Years) underperformed, posting returns of 1.28% and 1.70%, respectively.
Exhibit 1: Year-to-Date Municipal Total Returns
Source: Bloomberg. As of 30 June 20. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.
Muni market outlook:
- Municipalities will undoubtedly grapple with acute budget stresses associated with COVID-19. May unemployment rates as high as 25.2% in some states will result in lower tax collections and drive austerity measures at the state and local levels. This degree of austerity and budgetary pain on those downstream entities will be on a case-by-case basis, and will ultimately be informed by the length of regional shutdowns and the degree of aid that is provided by Congress.
- Despite the challenged fundamentals associated with COVID-19, we are constructive on the cyclical and secular prospects for the municipal asset class which we believe will benefit from favorable after-tax relative valuations versus other fixed-income asset classes as global yields continue to grind lower and the prospect for higher tax rates.
- While certain segments of the muni market have normalized to pre-COVID valuations, we continue to find value in some of the least-loved segments of the municipal market this year. Looking to the issuer level in the transportation and healthcare sectors, we seek issuers with the revenue diversity and cash on hand to weather the economic challenges associated with COVID-19.
Exhibit 2: General Obligation vs. Revenue Spreads to Index
Source: Bloomberg Barclays Municipal bond Index. As of 30 June 20. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.
Exhibit 3: Municipal Bond Yields and Index Returns
Source: (A) Muni Yields: Thomson Reuters Money Market Directory; Treasury Yields: Bloomberg. As of 03 July 20. (B) Bloomberg. Taxable Equivalent Yield assumes a top marginal tax rate of 40.8%. As of 03 July 20. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.
Exhibit 4: Tax-Exempt and Taxable Municipal Valuations
Source: Bloomberg, Western Asset, Taxable Muni Index Corporate comparable used is the Long Corporate (ex. BBB) to better align credit quality and duration. As of 03 July 20. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.
Definitions:
Lipper is a fund research organization whose fund-classification strategy is used to attribute performance of U.S. and non-U.S. equity, fixed income funds and exchange-traded funds (ETFs).
Revenue Anticipation Notes (RANs) are a form of note, or short-term loan that a government usually repays from a named revenue source within a period of one year. The revenue that the government uses to repay a RAN can come from a variety of sources depending on the project, such as sales, fees, or rate increases.
Pollution Control Revenue (PCR) and Industrial Development Revenue (IDR) are the generic names for tax‐exempt debt issued by municipal authorities to finance projects or facilities used by private corporations.
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.
Investment-grade bonds are those rated Aaa, Aa, A and Baa by Moody’s Investors Service and AAA, AA, A and BBB by Standard & Poor’s Ratings Service, or that have an equivalent rating by a nationally recognized statistical rating organization or are determined by the manager to be of equivalent quality.
High yield (HY) bonds, also called junk bonds, are bonds with below investment-grade ratings (BB, B, CCC for example) and are considered low credit quality and have a higher risk of default.
The Bloomberg Barclays Municipal Bond Index is a rules-based, market value-weighted index engineered for the long-term tax-exempt bond market.
The Bloomberg Barclays Municipal High Yield (HY) Index is market value-weighted and designed to measure the performance of U.S. dollar-denominated high-yield municipal bonds issued by U.S. states, the District of Columbia, U.S. territories and local governments or agencies.
The Bloomberg Barclays Investment Grade Municipal Bond Index is a rules-based, market value-weighted index engineered for the investment-grade long-term tax-exempt bond market.
The yield curve is the graphical depiction of the relationship between the yield on bonds of the same credit quality but different maturities.
The belly of the yield curve generally considered to include the three- to seven-year maturities.
COVID-19 is the World Health Organization's official designation of the current novel coronavirus disease. The virus causing the novel coronavirus disease is known as SARSCoV-2.
One basis point (bps) is one one-hundredth of one percentage point.
Revenue bonds are supported by the revenue from a specific project, such as a toll bridge, highway, or local stadium.
General obligation (GO) bonds are issued directly by state or local governments or their agencies to meet essential government functions such as schools and highway construction. These bonds are backed by the issuer’s pledge and its full faith, credit and taxing power to meet interest and principal payments.
Yield-to-Worst (YTW) is the yield generated assuming a bond is redeemed by the issuer on the least desirable date for the investor. Yield-to-Worst for the asset class is calculated as the weighted average yield to worst of the individual constituent bonds.
A spread is the difference in yield between two different types of fixed income securities with similar maturities; usually between a Treasury or sovereign security and a non-Treasury or non-sovereign security.
The Municipal/Treasury Ratio (M/T ratio or muni-Treasury ratio) is a comparison of the current yield of municipal bonds to U.S. Treasuries. If the yield on AAA munis is 1.5% and the yield on the 10-year Treasury is 2.0%, the ratio is 0.75. The higher the muni-Treasury ratio, the more attractive munis are relative to Treasuries.
