Monthly Municipal Market Update, May 2021
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May Month in Review
U.S. markets experienced a tug of war through May – on one side, continued vaccination distribution efforts and reopenings propelled rapid economic recovery, while on the other side, concerns over inflation provided headwinds. Large-cap blue chips generally closed the month in positive territory, while the tech-heavy Nasdaq Composite logged declines.Footnote1 After a similarly volatile month, U.S. Treasury yields closed the month flat at the 20-year tenor, while down one to six basis points (bps) across the remainder of the curve.Footnote2
The municipal bond yield curve flattened slightly in May. Yields at tenors inside of 10 years generally increased – with the exception of the one-year tenor, which experienced a one basis point decline in yield – while yields at tenors beyond 10 years decreased. The 10-year tenor of the AAA Municipal Market Data (MMD) curve closed the month at 0.99%, identical to April’s final print.Footnote3 With demand for municipals remaining firm even in the face of rich AAA valuations, municipal fund inflows are on pace for a record year (+$49.7 billion year-to-date).Footnote4
Meanwhile, the supply of federally tax-exempt municipals remains constrained – a trend expected to persist as we enter the summer months, which typically see reinvestment capital outpacing new issuance. In May, just $24.2 billion of total debt came to market – a 39% decline from April’s $40 billion in muni issuance. This marks the lowest monthly supply figure year-to-date. Taxable municipal issuance, which totaled $5.1 billion in May, decreased by 55% month-over-month. Footnote5*
- On the final business day of May, the Treasury Department released its Green Book of proposed changes to federal tax law. Included in the proposal is the authorization of $50 billion in direct-pay Qualified School Infrastructure Bonds, as well as a doubling of the limit on tax-exempt private activity bonds for transportation. Not included in the plan is the reinstatement of the tax exemption for advance refunding bonds, which is largely viewed as a top priority sought by state and local governments and enjoys bipartisan support.Footnote6 Nonetheless, the restoration of tax-exempt refunding bonds could still happen as part of a comprehensive infrastructure bill.
- Municipal bonds experienced another solid month of performance in May, supported by favorable technicals. The Bloomberg Barclays Municipal Bond Index posted a 0.30% gain, the Bloomberg Barclays High Yield Municipal Bond Index returned 1.15%, and the Bloomberg Barclays Taxable Municipal Index advanced by 0.67% over the month. May’s performance brings year-to-date total returns for the three indices to 0.78%, 4.80%, and -1.35%, respectively.Footnote7
- A flattening municipal yield curve and lower U.S. Treasury bond yields led to a widening in municipal taxable-equivalent yield spreads at the front end of the curve and a corresponding tightening at the long end of the curve. At month-end, spreads equated to one basis point at the five-year tenor (up from -13 bps), eight bps at the 10-year tenor (up from three bps), four bps at the 20-year tenor (down from 17 bps), and 28 bps at the 30-year tenor (down from 38 bps).Footnote8
- Much like the primary market, the secondary market experienced a relatively slow month. Secondary market trade activity in May, as measured by the month’s 621,000 total trades, marked the lowest figure of the year thus far. Total par traded in May amounted to $174 billion (down from $197 billion in April).Footnote9
Muni credits in focus: Municipal credit trends continue to improve
The Bloomberg Barclays Municipal Bond index returned 0.30% in May, representing the third straight month of positive returns for the municipal market.Footnote10 With credit spreads continuing to tighten, the Bloomberg Barclays Municipal High Yield Index posted a 1.15% monthly return.Footnote11 Despite notable economic data over the month, municipal yields generally held steady, buoyed by strong fundamentals. Retail demand for municipals persisted in May, as municipal funds saw a weekly average of $905 million in inflows.Footnote12 Meanwhile, monthly net issuance of $23.8 billion was down ~23% from last May, as issuers await the potential arrival of federal aid.Footnote13
Over the month, the much-discussed American Rescue Plan relief funding began to flow to municipalities. The U.S. Treasury began distributing the first tranche of funds to governments, while releasing guidance on how direct state and local aid may be used. The Treasury is giving states fairly wide latitude on how to utilize the funding, including an ability to enact state tax cuts as long as certain conditions are met that protect the cuts from being entirely funded by federal aid. May saw historic budgets released from several states, including California’s $268 billion proposed FY22 spending plan that would significantly boost funding to state-dependent sectors like school districts, community colleges, and public higher education.
Rating agencies have signaled a more optimistic outlook on the municipal landscape as even some hard-hit borrowers like New York City have seen their rating outlooks revised to stable from negative.Footnote14 We continue to see high-profile upgrades, such as the University of Illinois, that are driven by the unprecedented federal support and resultant improved state budget outlooks.Footnote15 Overall, rating upgrades rapidly outpaced downgrades by a more than 2-to-1 margin in the first quarter of 2021 – though part of this trend is attributable to rating methodology changes.Footnote16 We expect most property-tax-dependent local governments to continue seeing auspicious credit trends in the coming year given the rapid increase in home prices that should benefit local tax coffers.Footnote17
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- Municipals turned in another solid month of performance in May, with high yield munis leading the way as credit spreads continued to tighten.
- Demand for municipals was again robust over the past month, with muni fund inflows on pace for a record year.
- Underscoring an improving credit outlook, a number of high-profile municipal issuers saw their credit ratings upgraded in May.
Past performance is not a guarantee or a reliable indicator of future results.
A word about risk: Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Income from municipal bonds is exempt from federal income tax and may be subject to state and local taxes and at times the alternative minimum tax; a strategy concentrating in a single or limited number of states is subject to greater risk of adverse economic conditions and regulatory changes. High yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not.
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The credit quality of a particular security or group of securities does not ensure the stability or safety of an overall portfolio. The quality ratings of individual issues/issuers are provided to indicate the credit-worthiness of such issues/issuer and generally range from AAA, Aaa, or AAA (highest) to D, C, or D (lowest) for S&P, Moody’s, and Fitch respectively. The terms “cheap” and “rich” as used herein generally refer to a security or asset class that is deemed to be substantially under- or overpriced compared to both its historical average as well as to the investment manager’s future expectations. There is no guarantee of future results or that a security’s valuation will ensure a profit or protect against a loss.
Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice.
Forecasts, estimates and certain information contained herein are based on proprietary research and should not be interpreted as investment advice, as an offer or solicitation, nor as the purchase or sale of any financial instrument. Forecasts and estimates have certain inherent limitations, and unlike an actual performance record, do not reflect actual trading, liquidity constraints, fees, and/or other costs. In addition, references to future results should not be construed as an estimate or promise of results that a client portfolio may achieve.
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Bloomberg Barclays Municipal Bond Index consists of a broad selection of investment-grade general obligation and revenue bonds of maturities ranging from one year to 30 years. It is an unmanaged index representative of the tax-exempt bond market. The index is made up of all investment grade municipal bonds issued after 12/31/90 having a remaining maturity of at least one year. The Bloomberg Barclays High Yield Municipal Bond Index measures the non-investment grade and non-rated U.S. tax-exempt bond market. It is an unmanaged index made up of dollar-denominated, fixed-rate municipal securities that are rated Ba1/BB+/BB+ or below or non-rated and that meet specified maturity, liquidity, and quality requirements. The Barclays Taxable Municipal Index represents a rules-based, market-value weighted index engineered for the long-term taxable bond market. For inclusion in the Index, bonds must be rated investment grade quality or better, have at least one year to maturity, have a coupon that is fixed rate, have an outstanding par value of at least $7 million, and be issued as part of a transaction of at least $75 million. The Intermediate Municipal subsector groups together securities with an average maturity between one to 10 years. The Barclays 1-10 Year Municipal Bond Index is an unmanaged index considered to be generally representative of investment-grade municipal issues having remaining maturities from 1-10 years and a national scope. It is not possible to invest directly in an unmanaged index.
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