Municipal Market Update: November

Municipal Market Update: November

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


Performance

  • The muni market sold off during November as investors began to reposition their portfolios in anticipation of a dramatic pick-up in new supply.
  • The Bloomberg Barclays Municipal Bond Index declined -0.54% in November compared with a -0.13% pullback in the broad taxable market, as measured by the Bloomberg Barclays U.S. Aggregate Bond Index.
  • Year-to-date through November, the Bloomberg Barclays Municipal Bond Index returned +4.36% compared with +3.07% for the Bloomberg Barclays U.S. Aggregate Bond Index.
  • Revenue bonds held up better than General Obligation (GO) bonds in November, slipping -0.46% versus -0.65%; and Revenue bonds outperformed for the year-to-date period as well, 4.80% versus 4.18%
  • High yield municipal bonds posted a modest gain in November (+0.25%) and generated a total return of 8.29% for the year-to-date period.

Revenue bonds outperformed G.O. bonds for all periods shown below

 

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

Source: Bloomberg Barclays, as of 11/30/17. 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

  • Municipal new issue supply was just shy of $41 billion in November, up 23% month-over-month.
  • On a year-to-date basis, total issuance was $368 billion, down 14% from the same period a year ago.
  • Fund flows into long-term mutual funds and ETFs have been positive each month this year; in November, they were over $2.6 billion and totaled nearly $33 billion for the year-to-date period.

Muni issuance: 2017 YTD vs. 2016 YTD

 

Muni issuance: 2017 YTD vs. 2016 YTD

Source: Bloomberg Barclays, as of 11/30/17.

 

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 12/05/17. October flows are estimated as of the week ending 11/29/17. 

 

Valuation

  • During November, the curve flattened with short-term yields rising dramatically.
  • Yields rose more the 30 basis points (bps) in the five-year area of the curve and almost 50bps in the two-year part of the curve.
  • The long end of the curve moved in a similar manner to US Treasuries, with yields unchanged to slightly lower.
  • Ratios cheapened across all maturities indicating municipals underperformed Treasuries.
  • The 10-year AAA muni to US Treasury ratio is currently at 92%, and on the long end is slightly above 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 11/30/17. 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 year1.32%1.61%82.13%2.33%
3 year1.61%1.89%84.94%2.84%
5 year1.78%2.14%83.09%3.14%
10 year2.21%2.41%91.75%3.91%
30 year2.86%2.83%101.14%5.05%
BBB Revenue    
1 year1.83%1.61%113.57%3.23%
3 year2.21%1.89%116.83%3.91%
5 year2.46%2.14%114.99%4.34%
10 year3.15%2.41%130.55%5.56%
30 year4.04%2.83%142.89%7.14%

Source: Bloomberg Barclays, as of 11/30/17. 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

  • Tax reform dominated our conversations throughout the month of November. On November 2nd, the House of Representatives introduced details to their long anticipated tax reform package only to be followed roughly a week afterwards with the Senate sharing details of their tax reform package.
  • Both versions included a couple of surprises for municipal investors, but thankfully, and as we expected, both plans were generally a net positive for the municipal bond market, in our opinion.
  • The surprises included in both plans, and we view them as minor surprises, were the elimination of advanced refundings and eliminating issuance of other types of municipal debt, such as 501(C)(3) stadium financings and private activity bonds (PABs).
  • PABs are mostly used for infrastructure related projects so it’s a bit of a head scratcher considering a handful of Senators were recently crafting legislation to expand the use of PAB’s to finance infrastructure projects.
  • That aside, a lower corporate rate and the capping of deductions were expected.
  • Looking ahead we may see less demand for municipal bonds from corporations in the future, but we expect any drop in demand will happen over time and not in the immediate future.
  • Another surprise occurred when the Alternative Minimum Tax (AMT) found its way back at the last minute into the Senate’s version of tax reform. If this provision remains in the final version of the reconciled bill, we expect AMT bonds to weaken versus other debt, especially given AMT spreads tightened more than 20bps during the past year.
  • AMT aside, because investors pin a high probability to tax reform passing, municipal investors should anticipate a rush before year end from some municipal authorities to issue debt that will no longer be eligible to be issued next year.
  • Although that may pressure prices in the near term, the drawing of supply into this calendar year from the upcoming year will lend itself, we believe, to a favorable technical landscape during the upcoming months.
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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.