December 23, 2019
After reaching all-time lows in municipal-to-Treasury ratios in May, municipals’ performance began to experience relative softness throughout the third quarter. While long-duration Treasury yields fell to all-time lows in August, ratios reset to higher levels, contributing to the end of 10 consecutive months of positive performance for the Bloomberg Barclays Municipal Bond index. The municipal market’s streak of consecutive weekly inflows continued for 2019, accumulating to $74 billion year to date, offsetting the 19 percent year-over-year increase in new issue supply.
Taxable new issuance, which surpassed $40 billion for the first time since the Build America Bonds program in 2009–2010, boosted overall supply.
Source: Guggenheim Investments, BondBuyer, SIFMA. Data as of 10.31.2019.
Crossover buyers welcomed the surge in taxable new issuance, as it offered name diversification, lower default probability, healthy ESG factors, and lower correlations to corporate markets. Since September, issuers have capitalized on the Treasury rally by issuing taxable bonds not only for new money, but for advance refunding of tax-exempt bonds. Although the Tax Cuts and Jobs Act eliminated advance refundings with tax-exempt bonds, the arithmetic of the current rate environment has encouraged issuers to execute similar financing strategies with taxable bonds several years ahead of par call dates. Low absolute yields, combined with the Treasury curve’s bull flattening, afforded issuers very low negative arbitrage (i.e., the difference between escrow earnings and borrowing rates until the call date) that can be dwarfed by the cost savings of replacing 5 percent coupons on tax-exempt bonds with borrowing rates near 3 percent.
The momentum of this supply phenomenon has broadened the municipal demand base and supported a bullish backdrop for the tax-exempt market, particularly for bonds with shorter call dates. The series of favorable technical factors throughout the year has helped push credit spreads to the tightest levels in the past decade. Meanwhile, state and local governments’ debt and unfunded pension liabilities has remained above 400 percent of tax revenues since the last recession. We believe this cognitive dissonance provides an opportunity to forgo very marginal carry in order to be selective and move up significantly in credit quality.
State and local governments’ debt and unfunded pension liabilities has remained above 400 percent of tax revenues since the last recession.
Source: Guggenheim Investments, U.S. Bureau of Economic Analysis, Federal Reserve. Data as of 3.31.2019.
—James Pass, Senior Managing Director; Allen Li, CFA, Managing Director; Michael Park, Vice President
This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.
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