A brief monthly update on what's happening in the municipal bond market.
Image Pop Up
IMPORTANT NOTICE: Please note that the following contains the opinions of the manager as of the date noted, and may not have been updated to reflect real-time market developments. All opinions are subject to change without notice.
Month in review
June was characterized by volatility in the equity market, with stocks pushed and pulled in opposite directions by the gradual re-opening of many states’ economies. This was followed by a surge in new coronavirus cases that has forced at least 19 states to pause reopening efforts. Despite both the S&P 500 and DJIA ending the month just a tick above where they started, each index closed the quarter with its largest quarterly gain in over two decades. After May’s prolonged rally, the AAA Municipal Market Data (MMD) yield curve flattened modestly in June, with shortterm rates up from 1 – 14 basis points (bps) inside of 12 years, and intermediate- and long-term rates down by 1 – 2 bps beyond 17 years. Yields remained flat from the 13-year tenor of the curve to the 16-year tenor, where demand was met with ample supply. The 10-year tenor ended the month at 0.90%.1 June saw $45.3billion in new municipal issuance — approximately $15.8 billion of which was attributable to taxable municipal debt. This marked a significant increase over May’s $29.6 billion figure and signified the highest tally since November 2019.2
The Federal Reserve’s rate-setting committee left short-term interest rates unchanged at its June meeting, signaling through its dot plot that it could be years until rates are hiked. Addressing the Municipal Lending Facility, Fed Chair Jerome Powell said the central bank is reviewing the credit thresholds of the program, including a possible expansion to territories that do not qualify under current guidelines.3
Municipal bond indices experienced another positive month of returns in June. The Bloomberg Barclays Municipal Bond Index returned 0.82% and the Bloomberg Barclays High Yield Municipal Bond Index returned 3.96%, bringing year-to-date total return for the two indices to 2.08% and –2.64%, respectively.4
Muni/Treasury ratios increased at the front end of the curve in June. The one-year ratio ended the month at 156% (up from 65% at the end of May). The two-year ratio ended the month at 180% (up from 100%), the five-year ratio at 141% (up from 127%), and the 10-year ratio at 136% (up from 129%). Ratios remained broadly unchanged in the intermediate portion and long end of the curve, with 15-year ratios holding steady at 119% and the 30-year ratio ending the month at 115% (down from 116%).5
Muni/Treasury taxable-equivalent spreads* also increased at the short end of the curve in June. At month-end, spreads equated to 26 bps at the one-year tenor, 31 bps at the twoyear tenor, 40 bps at the five-year tenor, and 86 bps at the 10-year tenor.6
June’s secondary market trade activity nearly mirrored that of May. June’s 703,000 total trades reflected just a 2.5% decline from May’s 722,000 trades, while the $244 billion in par traded during the month showed a 4.1% increase from May’s $234 billion.7
Muni technicals in focus: Issuance normalizes in the muni market
With nearly 2.6 million COVID-19 cases in the U.S. and accelerating reports of daily new infections across the country, some states are pausing to reconsider reopening plans. 8 9 Despite the alarming resurgence of cases, economic data throughout June was generally strong. The S&P closed its best quarter since 1998 with an approximately 20% quarterly gain, while the Bloomberg Barclays U.S. Aggregate Bond Index returned 0.63% on the month. 10 11 Following last month’s positive return, the Bloomberg Barclays Municipal Bond Index gained 0.82% in June.12
Seasonal tailwinds tend to bolster the municipal market during the summer months, with elevated reinvestments of debt payments generally outstripping supply. Robust retail demand absorbed the relative pickup in volume, with municipal funds experiencing a $12.7 billion influx this month.13 June saw $45.3 billion in new issuance the highest level since November, with taxable issuance comprising more than one third of this total.14
While corporate yields declined in June given continued Federal Reserve support, municipal yields remained generally steady, despite the expansion of the Municipal Liquidity Facility.15 The Federal Reserve authorized each state to have at least two additional cities or counties, regardless of population, eligible to access the Facility.16 Furthermore, governors can now designate two revenue bond issuers in their states as eligible borrowers, generally entities with revenues derived from operating government activities.17 Thus far, the New York MTA has been designated as an eligible revenue bond issuer, and the State of Illinois became the first borrower to utilize the Facility, with a one year $1.2 billion loan at a 3.82% rate.18 19
Notably, about 9% of new issues this month were offered with bond insurance, nearly 47% higher than June of last year, suggesting market concern regarding municipal creditworthiness 20 June continued to provide evidence of the pandemic’s significant budgetary impact on state and local government revenue collections. Using monthly revenue data released through June, the Tax Policy Center forecasts that states may see approximately $125 billion in tax revenue shortfalls in Fiscal Year 2021, which began on July 1 for 46 states.21Some estimates put the figure even higher. Although these shortfalls are driving difficult decisions for governments, we note that these estimates are improved from some of the more dire projections that third parties have published in recent months.22 Much of the budget outlook will depend on the success and timing of reopening economies. Given the surge in hospitalizations and the decision to pause or even roll back reopening in some states we may see revenue trends take a turn for the worse in coming months. However, we have seen state and local governments take swift action to cut spending, illustrated by the nearly 1.5 million state and local government jobs that were shed since March.23
Municipalities are taking the steps we expected to manage through a difficult budget environment, including cutting jobs and leaning on accumulated reserves, but attention remains on Washington, D.C., as the U.S. Senate is expected to take up debate on the next phase of stimulus upon their return from July recess. Although the fate of additional state and local aid is uncertain, there is cautious optimism among state policymakers that Congress will provide some additional help (even if it is limited to flexibility on how to spend already allocated CARES Act funding). While any new aid or flexibility may come with restrictions to avoid federal assistance being used for items like pension contributions, we believe any additional federal aid would be positive for municipal credit conditions. We do not have the same optimism for passage of the House’s version of a $1.5 trillion infrastructure bill that would have brought back advance refundings ; the bill in its current form appears to have little support in the Senate, although it could be considered under a new Congress in 2021 depending on the outcome of the election in November.24
1 Thomson Reuters TM3 MMD Interactive Data, 30 June 2020; Madeline Holcombe, “At least 19 US states have paused reopening plans as cases rise”, CNN, 1 July 2020. 2 The Bond Buyer: Primary Market Statistics – A Decade of Bond Finance, 30 June 2020 3 Anneken Tappe, “Fed Says it Will Keep Stimulus Coming for Years,” CNN Business, 10 June 2020; Sarah Wynn, “Fed Reviewing Credit Standards in MLF Program,” Bond Buyer, 30 June 20204 Bloomberg Barclays, 30 June 2020 5 Thomson Reuters TM3 MMD Interactive Data, 30 June 2020 6 Thomson Reuters TM3 MMD Interactive Data, 30 June 2020 7 SIFMA: US Municipal Trading, 1 July 2020; The Bond Buyer: Secondary Market Data, 30 June 2020 8 CDC, “Cases in the U.S”, 30 June 2020 9 The New York Times, “U.S. States Backtrack on Reopening as Coronavirus Cases Climb”, 27 June 2020 10 Bloomberg, 30 June 2020 11 Bloomberg Barclays Indices, 30 June 2020 12 Ibid 13 Refinitiv Lipper, 1 July 2020 14 The Bond Buyer, “Bond Sales (Latest Month)”, 30 June 2020 15 Thomson Reuters TM3 MMD Interactive Data, 30 June 2020 16 Federal Reserve Release, “Federal Reserve Board announces an expansion in the number and type of entities eligible to directly use its Municipal Liquidity Facility,” 3 June 2020 17 Ibid 18 The Bond Buyer, "New York MTA eligible for Fed liquidity program”, 4 June 2020 19 Financial Times, “Illinois taps Federal Reserve for $1.2bn emergency funding”, 3 June 2020 20 The Bond Buyer, “Bond Sales (Latest Month)”, 30 June 2020 21 Lucy Dadayan, “COVID-19 Pandemic Could Slash 2020-21 State Revenues By $200 Billion,” Tax Policy Center, 1 July 2020 22 For reference, the Center on Budget and Policy Priorities estimates that state budget shortfalls in FY21 will total $315 billion. 23 Barb Rosewicz & Mike Maciag, “Cuts to payrolls are mostly temporary for now, but decisions ahead will depend on the virus and budget stresses,” PEW, 16 June 2020 24 Tanya Snyder, “House sends massive infrastructure bill to the Senate, where it has no path forward,” Politico, 1 July 2020
Image Pop Up
