Municipal Market Update: February

Municipal Market Update: February

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


Performance

  • Generally speaking, positive US economic data along with loose financial conditions served as a backdrop for voting members of the Fed to project a more hawkish tone, foreshadowing the March rate decision.
  • February saw steady positive returns for munis in all sectors, with high yield and longer duration bonds outperforming. 
  • The Bloomberg Barclays Municipal Index returned 69 basis points (bps) for the month, bringing the YTD total return to 1.36%.   The municipal high yield index posted returns of 2.38%.  Munis also outperformed US Treasuries which returned 49bps for February. 
  • Also, it’s noteworthy to mention that Hospital returns resumed positive after previous uncertainty regarding the future of the Affordable Care Act.

 

Revenue bonds outperformed G.O. bonds for the last 12 months

 

Source: Bloomberg Barclays, as of 2/28/17. 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

  • In contrast to January’s robust calendar, muni issuance totaled a mere $21 billion in February.  Aside from being down 36% m/m and 32% y/y, this is the smallest issuance for the month since 2000. 
  • Year-to-date gross issuance is approximately $55 billion with net issuance of -$2 billion.  (The chart below shows issuance through January 2017).
  • Muni fund flows remained positive in February.  Inflows averaged about $700mm per week with HY seeing the strongest interest among investors.  
  • ICI data indicates that fund flows totaled approximately $2.7bn for the February, bringing the YTD number to $6.8bn.  It’s important to note, if rates begin to adjust swiftly higher, flows could turn negative.  

Muni issuance: 2017 YTD vs. 2016 YTD

 

Source: Bloomberg Barclays, as of 1/31/17.

 

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

 

Source: Source: Investment Company Institute, Washington DC, as of 3/08/17. February flows are estimated as of the week ending 3/01/17. 

 

Valuation

  • From a curve perspective, munis are higher and flatter than a year ago but the curve did steepen during February as maturities inside of 10yrs outperformed more than those on the long end (bull curve steepener). 
  • Ratios tightened on the month as munis outperformed US Treasuries.  2yr ratios tightened by 11bps while 10yr and 30yr ratios richened by roughly 3bps during February.

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

 

Source: Bloomberg Barclays, as of 2/28/17. 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 year0.79%0.82%96.37%1.40%
3 year1.16%1.52%76.13%2.04%
5 year1.55%1.93%80.44%2.74%
10 year2.30%2.39%96.36%4.07%
30 year3.10%3.00%103.43%5.47%
BBB Revenue    
1 year2.09%0.82%254.03%3.68%
3 year2.57%1.52%169.34%4.54%
5 year2.86%1.93%148.40%5.06%
10 year3.66%2.39%153.23%6.47%
30 year4.63%3.00%154.52%8.18%

Source: Bloomberg Barclays, as of 2/28/17. 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

  • Keep in mind, muni yields generally follow Treasury yields.  That said, we are cautiously observant that muni performance could come under pressure over the near term, particularly if the Treasury market weakens due to events around the pace of monetary tightening or continued prospect of looser fiscal policy.
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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.

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