SUMMARY
- In the wake of October’s record supply, municipal issuance largely evaporated in November, even as demand remained robust.
- Treasury Secretary Steven Mnuchin signaled his intent to allow the Municipal Liquidity Facility to expire at the end of the year; however, it remains to be seen if the facility will be revived under the Biden administration.
- Optimism around COVID-19 vaccines improved the credit outlook for key municipal sectors in November, including airports and transportation.
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Month in Review
The U.S. stock market surged in November, erasing October’s losses even amid a rising number of coronavirus infections. Propelled by progress toward potential coronavirus vaccines and hopes for a relatively smooth transition to power for president-elect Joe Biden, major U.S. equity indices closed the month with double-digit gains. Footnote1 Meanwhile, the municipal market was characterized by a falloff in supply and robust demand. In the wake of October’s $72+ billion of issuance, just $18.8 billion was brought to market in November, of which $4.8 billion was taxable. Monthly issuance not only fell to its low-water mark for the year, but also represented the weakest monthly figure since February 2018. Footnote2 Decreased supply, coupled with increased demand for longer-duration bonds, resulted in a bull flattener for the AAA Municipal Market Data (MMD) curve. Yields dropped by 5-7 basis points (bps) inside of 5 years, by 11-21 basis points from 6-10 years, by 23-29 bps from 11-15 years, and by 30 bps beyond 15 years. Footnote3 Entering the holiday season, net negative supply may provide a tailwind for the municipal market as we close out 2020.
- Treasury Secretary Steven Mnuchin indicated that he has no intention of renewing the Municipal Liquidity Facility (MLF) for the forthcoming year. Footnote4 The lending facility, which serves as a backstop for struggling municipal issuers, is currently set to expire at the end of the year, although it could be resuscitated in 2021 under the Biden administration. While the MLF has remained broadly underutilized due to its steep borrowing costs – only the state of Illinois and New York’s Metropolitan Transportation Authority have tapped it – the move still surprised many market participants. Federal Reserve Chairman Jerome Powell previously expressed support for an extension of the MLF, and the Fed responded to Mnuchin’s decision with a statement signaling its disappointment.
- Municipal bonds generated relatively strong performance in November. The Bloomberg Barclays Municipal Bond Index returned 1.51% for the month, while the Bloomberg Barclays High Yield Municipal Bond Index gained 2.40% and the Bloomberg Barclays Taxable Municipal Index gained 1.91%. Year-to-date returns for the three indices currently stand at 4.58%, 2.96%, and 9.33%, respectively. Footnote5
- Treasuries also experienced positive performance in November, although they underperformed municipals, leading to a tightening in municipal/Treasury taxable-equivalent spreads.* At month-end, taxable-equivalent spreads equated to 13 bps at the one-year tenor (down from 21 bps), 3 bps at the five-year tenor (down from 13 bps), 38 bps at the 10-year tenor (down from 72 bps), and 80 bps at the 30-year tenor (down from 127 bps). Footnote6
- Secondary market trade volume sank to its lowest level in more than a decade. Trades for the month of November totaled just 549,000 (down from 679,000 in October) while par traded amounted to just $159 billion (down from $252 billion). Footnote7
Muni technicals in focus: Munis demonstrate firmness as issuance evaporates
Encouraging vaccine prospects and post-election clarity spurred a broad market risk-on move in November. The Dow Jones Industrial Average jumped nearly 12%, posting its largest monthly gain since January 1987. Footnote8 As risk assets generally rallied, the 10-year Treasury yield climbed to 0.98%, its highest level since March. Footnote9 However, a surge in new coronavirus infections and renewed lockdowns largely suppressed Treasury yields, which closed the month roughly flat. Footnote10 While municipals generally tracked Treasuries, the municipal curve flattened over the month, and the 10-year AAA municipal yield slipped ~20 bps to 0.72%. Footnote11 As such, the 10-year municipal/Treasury ratio declined from 108% to ~86% – in line with pre-pandemic levels. Footnote12
The resiliency exhibited by municipals can largely be attributed to supply/demand dynamics. November saw just $18.84 billion in new issuance – the lowest volume for the month since 1999. Footnote13 However, this figure can largely be attributed to a concerted effort by issuers to close deals ahead of the November elections – contributing to both October’s record supply and November’s comparatively lackluster numbers. Monthly taxable issuance, which has surged this year, was just $4.82 billion, down 60% from last November. Footnote14 Nonetheless, demand remained robust, with retail municipal investors adding a weekly average of ~$516 million to municipal funds during the month. Footnote15 Following October’s negative return, the Bloomberg Barclays Municipal Bond Index returned 1.51% in November. Footnote16 With risk appetites expanding, the Bloomberg Barclays Municipal High Yield Bond Index posted a 2.40% monthly return. Footnote17
The COVID-19 pandemic remained the dominant credit theme in November. We believe the winter months are likely to bring additional credit stress and revenue loss across a variety of sectors, which could lead to rating agency downgrades. Nonetheless, we believe default risk is minimal in the high quality space, as most municipal issuers started the process of reducing expenditures and preserving liquidity in the spring in preparation for an uncertain fiscal outlook.
November also brought glimmers of hope – due in part to promising news about several COVID-19 vaccine candidates. These developments led to a marked improvement in the credit outlook for municipal sectors that have been hard hit by the pandemic, notably airports and transportation credits. Despite optimism that travel volumes may return to some semblance of normalcy in 2021, we believe that credit selection is key. We continue to focus on individual issuers with sufficient liquidity to withstand potentially slow-growth conditions and periodic market disruptions.
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1 Joe Wallace and Akane Otani, “Dow Falls but Holds On for Best Month in Over Three Decades,” Wall Street Journal, 30 Nov 2020↩
2 The Bond Buyer: Primary Market Statistics – A Decade of Bond Finance, 30 Nov 2020↩
3 Thomson Reuters TM3 MMD Interactive Data, 30 Nov 2020↩
4 Nick Timiraos and Kate Davidson, “Mnuchin Declines to Extend Several Fed Emergency Lending Programs,” Wall Street Journal, 19 Nov 2020↩
5 Bloomberg Barclays, 30 Nov 2020↩
6 Thomson Reuters TM3 MMD Interactive Data, 30 Nov 2020↩
7 The Bond Buyer: Secondary Market Data, 30 Nov 2020; SIFMA: US Municipal Trading, 1 Dec 2020↩
8 Bloomberg ↩
9 Thomson Reuters TM3 MMD Interactive Data, 30 Nov 2020↩
10 Ibid↩
11 Ibid ↩
12 Ibid↩
13 The Bond Buyer, “Bond Sales (Latest Month)”, 30 Nov 2020↩
14 Ibid↩
15 Refinitiv Lipper, 2 Dec 2020↩
16 Bloomberg Barclays Indices, 30 Nov 2020↩
17 Ibid↩
© PIMCO
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