Western Asset examines recent trends in the muni bond market and provides its outlook about conditions ahead.
- 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
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.
- 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
Source: Bloomberg Barclays, as of 6/30/18.
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.
- 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
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
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.
- 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.