Municipal Market Update: April

Municipal Market Update: April

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


Performance

  • The municipal bond market posted good performance during month of April.
  • Generally, the intermediate maturity range between six and seventeen years outperformed other areas of the market.
  • Revenue bonds outperformed G.O. debt, and high yield bonds continued to outperformed investment grade.
  • More importantly, the municipal market performed well during the first four months of 2017 despite being overshadowed by public policy uncertainty, including health care repeal and tax reform, neither of which seemed to worry investors. 

 

Revenue bonds outperformed G.O. bonds over the past 12 months

 

Source: Bloomberg Barclays, as of 4/30/17. 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

  • Issuance slowed down during the month of April and the same is true year to date versus prior year’s supply.
  • So far, we have seen roughly $105b of new tax-exempt bonds and approximately $10.5b of new taxable municipals.
  • While taxable supply is higher by 14% this year, traditional tax-exempt supply is down about 15%. All combined supply is down 12% versus last year’s numbers.
  • Inflows to mutual funds resumed with the majority of investments going into high yield funds.
  • Healthy inflows have created a favorable technical landscape driving municipal yield ratios somewhat lower.

Muni issuance: 2017 YTD vs. 2016 YTD

 

Source: Bloomberg Barclays, as of 4/30/17.

 

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

 

Source: Source: Investment Company Institute, Washington DC, as of 5/03/17. April flows are estimated as of the week ending 4/26/17. 

 

Valuation

  • We continue to view the ten to twenty year maturity range as the most attractive.

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

 

Source: Bloomberg Barclays, as of 4/30/17. 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 year0.84%1.06%79.52%1.49%
3 year1.18%1.44%81.50%2.08%
5 year1.45%1.81%80.04%2.57%
10 year2.16%2.28%94.86%3.82%
30 year3.02%2.95%102.28%5.33%
BBB Revenue    
1 year1.83%1.06%172.76%3.23%
3 year2.30%1.44%159.20%4.06%
5 year2.58%1.81%142.38%4.56%
10 year3.34%2.28%146.41%5.90%
30 year4.30%2.95%145.60%7.59%

Source: Bloomberg Barclays, as of 4/30/17. 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

  • Regarding tax reform, themes were released by the current administration at the end of April but not many details. Municipal tax exemption was not identified as being at risk. However, there remain a lot of unknowns as many tax reform details still need to be negotiated. Our view is that tax reform will prove mostly positive for municipal bond investors.
  • With regard to Puerto Rico, the rock fight that we have been talking about over the years started to break out amongst the various debt holders. In the past we have expressed the point that most investors purchased Puerto Rico debt with a sense of the security of the bond and where they would stand should the specific issuer restructure. For example, the owners of Puerto Rico General Obligation debt believed that they were protected by constitutional provisions. By contrast, owners of COFINA were guaranteed first claim on sales tax revenues which far exceed the debt service. 
  • Changing the rules in the face of financial distress is problematic, but sometimes necessary and Puerto Rico is in the midst of changing the rules as they recently handed the task of negotiating debt restructuring over to the bankruptcy courts. Currently, we do not own any Puerto Rico debt in our portfolios.
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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.