SUMMARY
- Municipal bonds continued to rally in July, with the Bloomberg Barclays Municipal Bond Index up 1.68% for the third straight monthly gain.
- Driven in part by strong retail demand and significant reinvestment, short-term rates finished the month down 14–18 basis points while rates beyond five years finished down 22–26 basis points.
- Municipal bond issuance reached its highest level for the month of July in three decades, spurred largely by historic levels of taxable issuance comprising more than one-third of the $42.6 billion total.
Month in review
While the U.S. economy experienced modest growth in May and June, real U.S. GDP declined at a seasonally adjusted annualized rate of 32.9% in the second quarter, marking the steepest sequential decline in more than 70 years of record-keeping. In the municipal market, strong retail demand, significant reinvestment, and seasonal tailwinds in July drove yields lower across the AAA Municipal Market Data (MMD) curve in a bull flattener. Short-term rates ended the month down 14–18 basis points (bps), while rates beyond five years ended the month 22–26 bps lower. The 10-year tenor closed out the month at a historic low of 0.65%.1 The low absolute rate environment inspired municipal issuers to continue to tap into the taxable market. In fact, of the $42.6 billion of new money brought to market in July by an active primary market, taxable municipal debt accounted for $16.1 billion. Year-to-date taxable issuance has now surpassed the total for all of 2019.2
- No new policy action was announced at the conclusion of the Federal Reserve’s two-day meeting in July. Fed Chair Powell reiterated the central bank’s pledge to support the economy, but emphasized that any future action will be determined by the course of the pandemic and its effects on the economy. Earlier in the month, the Fed announced modifications to the Main Street Lending Program, including the expansion of access to credit for nonprofit organizations with as few as 10 employees. Certain municipal issuers will likely now be eligible.3
- Sustained demand for municipal bonds resulted in yet another month of positive returns for broad-market muni indices. In particular, the Bloomberg Barclays Municipal Bond Index advanced 1.68% in July and the Bloomberg Barclays High Yield Municipal Bond Index returned 2.72%, bringing year-to-date total returns for the two indices to 3.80% and 0.00%, respectively.4
- Muni/Treasury ratios compressed in July – most significantly at the front end of the curve. The one-year ratio ended the month at 92% (down from 156% at the end of June), the two-year ratio ended the month at 118% (down from 180%), the five-year ratio at 105% (down from 141%), and the 10-year ratio at 120% (down from 136%). Further out along the curve, ratios remained relatively unchanged with the 20-year ratio ending the month at 119% (down slightly from 122% and the 30-year ratio at 114% (down slightly from 115%).5
- Muni/Treasury taxable-equivalent spreads* also decreased in July. At month-end, spreads equated to seven bps at the one-year tenor, 11 bps at the two-year tenor, 17 bps at the five-year tenor, and 56 bps at the 10-year tenor.6
- Secondary market trade activity decreased for the fourth consecutive month in July, with 659,000 total trades marking the lowest figure since February. Par traded in the secondary market during July totaled 245 billion, in line with June’s $244 billion traded.7
Muni technicals in focus: Strong demand drives municipal yields to record lows
Although the U.S. recorded more than 1.9 million new COVID19 cases in July, representing more than 40% of its total identified cases to date, the growth of daily new infections tapered at month end.8 The Nasdaq rose nearly 700 points on the month, while the Bloomberg Barclays U.S. Aggregate Bond Index gained approximately 1.50%.9 The Bloomberg Barclays Municipal Bond Index climbed 1.68% in July, the third straight month of positive returns for the municipal market.10 Monthly new issuance of $42.6 billion was ~41% greater than July of last year, and the highest issuance reported for the month of July in three decades.11 However, taxable issuance accounted for $16.1 billion of this total, representing a more than 500% increase over July of last year.12 Despite the robust volume, seasonal dynamics persisted, with reinvestment capital outstripping supply. Retail assets continued to pour into municipal funds, averaging $2.35 billion of inflows on a weekly basis.13 Strong investor appetite for high quality municipals sent yields tumbling, with the 10 year AAA municipal yield closing the month at a record low of 0.65.14 However, many lower rated investment grade and sub investment grade issues have yet to fully recover. This could provide opportunities for investors in select credits particularly credits whose obligors possess solid balance sheets. With the Municipal Liquidity Facility operational, the Federal Reserve expanded the Main Street Lending Facility this month to include nonprofits with a minimum of 10 employees.15This program serves as another avenue of liquidity for certain eligible municipal issuers, particularly in the not for profit healthcare and higher education sectors.
State and local governments continue to grapple with uncertainty stemming from the effects of COVID 19, making operating and capital funding forecasts quite challenging. The most recent state tax data reflecting June activity still shows broad based yearly revenue declines; however, June sales tax trends have at least temporarily recovered from double digit declines experienced in the second quarter.16 While there were some modestly encouraging signs, such as California’s revenue declines coming in less severe than initially forecast and Texas seeing July sales tax revenues that actually exceeded July 2019 levels by more than 4%, we anticipate continued revenue weakness and negative budget headlines for many municipals.17 Despite partial reopenings , we still expect discretionary revenues (hotel tax, food and beverage, amusement tax) to remain depressed. Air and transit related travel continues to remain significantly below historic norms, although we have seen stronger recoveries in toll and traffic related volumes. Although we believe default risk within the investment grade municipal universe is very low, credit downgrade risks cannot be ignored. Recently, several airports and state governments have either been downgraded or have received negative outlooks, and Fitch placed the U.S. government’s sovereign AAA rating on negative outlook.18 We continue to monitor Congressional progress toward a Phase 4 stimulus bill. As of now, the House and Senate appear relatively far apart in their negotiations. We believe additional federal support in any form would be beneficial, as state and local governments are already proposing significant austerity measures to help close budget gaps.
1 Thomson Reuters TM3 MMD Interactive Data, 31 July 2020; Madeline Holcombe, “U.S. Economy Contracted at Record Rate Last Quarter; Jobless Claims Rise to 1.43 Million,” WallStreet Journal, 30 July 2020.
2 The Bond Buyer: Primary Market Statistics – A Decade of Bond Finance, 31 July 2020
3 Nick Timiraos, “Fed Maintains Stimulus Commitment as Economic Outlook Dims,” Wall Street Journal, 29 July 2020; “Federal Reserve Board modifies Main Street Lending Program to provide greater access to credit for nonprofit organizations such as educational institutions, hospitals, and social service organizations,” Federal Reserve Press Release, 17 July 2020
4 Bloomberg Barclays, 31 July 2020
5 Thomson Reuters TM3 MMD Interactive Data, 31 July 2020
6 Thomson Reuters TM3 MMD Interactive Data, 31 July 2020
7 SIFMA: US Municipal Trading, 3 August 2020; The Bond Buyer: Secondary Market Data, 31 July 2020
8 CDC, “Cases in the U.S”, 31 July 2020
9 Bloomberg, 31 July 2020
10 Bloomberg Barclays Indices, 31 July 2020
11 The Bond Buyer, “Bond Sales (Latest Month)”, 31 July 2020
12 Ibid
13 Refinitiv Lipper, 31 July 2020
14 Thomson Reuters TM3 MMD Interactive Data, 31 July 2020
15 Federal Reserve Release, “Federal Reserve Board modifies Main Street Lending Program to provide greater access to credit for nonprofit organizations such as educationalinstitutions, hospitals, and social service organizations,” 17 July 2020
16 PIMCO generated analysis – our review of monthly state revenue data shows June collections for the 22 states that had released robust data, the median total tax revenues weredown 4.2% from June 2019, and median state sales tax revenues were up 4.5% from June 2019 – compared to being down by more than 13% in May.
17 California Department of Finance, Finance Bulletin, July 2020; Texas Comptroller of Public Accounts, “State Sales Tax Revenue Totaled Nearly $3 Billion in July,” 3 August 2020.
18 As examples, S&P placed a Negative Outlook on the State of Michigan on July 14, 2020, assigned a Negative Outlook to Dallas Fort Worth Airport on July 17, 2020, and downgradedSan Francisco Airport on July 24, 2020. Moody’s downgraded the State of Hawaii on 31 July 2020.
© PIMCO
© PIMCO
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