Municipal Market Update: June

Municipal Market Update: June

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


Performance

  • Within a low volatility marketplace, municipal bonds posted dull returns in June. Prices were mostly negative, but income returns pushed total returns to a modest positive stance.
  • The Bloomberg Barclays Municipal Bond Index posted a positive total return of +0.09% in June, outperforming the Bloomberg Barclays U.S. Aggregate Bond Index (the benchmark for the taxable market), which returned -0.12%.
  • For the year-to-date period, the muni index was down -0.25%, but again better than its taxable counterpart, which was down -1.62%.
  • Meanwhile, high yield municipal bonds outperformed investment grade bonds as the Bloomberg Barclays High Yield Municipal Index posted a return of +0.50% in June and was up +3.66% for the year.

 

 

Revenue bonds outperformed G.O. bonds for the time periods shown below

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

Source: Bloomberg Barclays, as of 6/30/18. 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, has remained steady and positive.
  • A steady decline of new issue supply led some institutional traders to be somewhat more cautious when in the market as good replacement parts are scarce. Less bonds available at reasonable credit spreads, combined with a bland new issue calendar have contributed to an extended period of low price volatility.
  • Muni new issuance in June totaled $32 billion, down modestly from May’s 34 billion supply figure. Year-to-date, gross issuance was around 20% below the level for the first six months of 2017.
  • We are expecting the dynamics between supply and demand for munis to remain favorable during the next couple of months as bond redemptions are expected to remain high in July and 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 6/30/18.

 

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 7/05/18. June flows are estimated as of the week ending 6/27/18. 

 

Valuation

  • We expect valuations will be driven in the short term mostly by the balance between supply and demand, as we expect fundamentals to remain solid.
  • The 10-year AAA muni to US Treasury ratio is 86%, and on the long end is 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 6/30/18. 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%2.31%63.67%2.34%
3 year1.79%2.62%68.19%2.84%
5 year2.00%2.74%73.09%3.18%
10 year2.47%2.86%86.36%3.92%
30 year3.00%2.99%100.43%4.77%
BBB Revenue    
1 year1.92%2.31%83.21%3.05%
3 year2.32%2.62%88.52%3.68%
5 year2.54%2.74%92.76%4.03%
10 year3.19%2.86%111.61%5.07%
30 year4.09%2.99%136.91%6.50%

Source: Bloomberg Barclays, as of 6/30/18. 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

  • Last month we spoke about the Supreme court’s decision regarding sports betting and its potential modest yet positive impact to public finance.
  • This month’s Supreme court’s JANUS RULING could prove, in the long term, to be another modest credit positive as well but, currently, we view it with more uncertainty.
  • Moreover, if any positive credit momentum surfaces as a result of this ruling, it will be less than a widespread outcome. That leads us to conclude it is too early for investors to react to this ruling.
  • In the long term, as always, we will be following the impact of this ruling closely along with how well municipal authorities match expenses to revenues, and the balance between assets and upcoming liabilities in municipal pensions.

 

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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.