August 22, 2019
Municipals performed well as a safe-haven asset class amid geopolitical and trade tensions, modest economic data, and dovish Fed policy expectations. In the second quarter of 2019, tax-exempt municipal bond yields rallied, prompting spreads and municipal-to-Treasury yield ratios to reach new multi-decade rich levels. In the second quarter, 10-year and 30-year municipal-to-Treasury ratios averaged 76 percent and 89 percent, respectively, below the previous quarter’s averages of 80 percent and 98 percent. For the year-to-date period ending July 10, Lipper reported 27 consecutive weeks of net fund inflows amounting to a record-setting $48.8 billion.
For the year-to-date period ending July 10, Lipper reported 27 consecutive weeks of net fund inflows amounting to a record-setting $48.8 billion.
Source: Guggenheim Investments, JPMorgan, Lipper. Data as of 7.10.2019.
We expect this year’s theme of supportive supply-demand dynamics to continue through the summer as the municipal market experiences seasonal negative net supply. According to Citigroup, investors can expect an influx of $185 billion of returned capital (i.e., coupon payments, calls, and bond maturities), which would surpass the three-year trailing average of approximately $167 billion. At the current pace of only $28 billion of monthly new issue supply, municipal investors may face a challenging reinvestment environment. Issuers continue to enjoy favorable borrowing conditions in terms of costs, covenant provisions, and even coupon structures. For example, issuance of sub-5 percent coupon bonds increased to a record high of 46 percent of total supply, up from 38 percent in 2018; these lower coupon bonds offer much less liquidity because of possible negative tax consequences, unique to tax-exempt bonds, in a rising rate environment.
Meanwhile, investors’ unwavering demand was epitomized by idle reactions to negative credit headlines. Most notably, the U.S. First Court of Appeals upheld a ruling that upended a key structural protection of special revenue bonds, which account for roughly two-fifths of the outstanding municipal bond market. The Court ruled that debtors are permitted, but not required, to make debt service payments during bankruptcy proceedings, which would provide a form of automatic stay protection from bondholders. Subsequently, Moody’s and Fitch highlighted 13 issuers vulnerable to downgrades, but this action did not precipitate any unusual pricing volatility. Although low volatility has permeated most asset classes including municipals, we did not envision that such highly visible tail risks would be largely ignored. While municipal buyers’ risk tolerance continues to grow, investors should take the opportunity to shift portfolios to higher quality when possible.
The U.S. First Court of Appeals ruled that debtors are permitted, but not required, to make debt service payments during bankruptcy proceedings, which would provide a form of automatic stay protection from bondholders. Subsequently, Moody’s and Fitch highlighted 13 issuers vulnerable to downgrades, but this action did not precipitate any unusual pricing volatility.
Source: Bloomberg, Moody's, Fitch. Data as of 7.19.2019. *Basket includes 10 issuers vulnerable to rating downgrades related to potential treatment of special revenues bonds, as highlighted by Moody's and Fitch.
—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.
Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-backed securities, may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity risk. Investments in floating rate senior secured syndicated bank loans and other floating rate securities involve special types of risks, including credit risk, interest rate risk, liquidity risk and prepayment risk. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited, and Guggenheim Partners India Management.
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