Municipal Monthly

Monthly Municipal Market Update, February 2021

A brief monthly update on what's happening in the municipal bond market.

Figure 1 is a market snapshot table displaying yield and spread data as of 28 February 2021 for municipal bond markets and U.S. Treasury markets in maturities of 2, 5, 10, and 30 years. It also displays year-to-date data on municipal market issuance, fund flows, and index returns. Key takeaways are discussed in the copy within the article.

For the first time in months, the main story in U.S. markets centered on the bond market rather than the stock market. A wave of U.S. government bond selling in February drove yields to their highest levels since before the pandemic and cast doubt on investor expectations of long-term bond yields staying “lower for longer.” Federal Reserve (Fed) officials noted the sell-off was likely prompted by heightened expectations for economic recovery in the coming year, as coronavirus vaccine distribution continues and economic stimulus appears likely within the coming weeks.

The fixed income sell-off was not limited to government bonds; U.S. municipal bonds also saw yields rise dramatically. While AAA Municipal Market Data (MMD) yields inside of the 2-year tenor experienced single-digit increases, yields from the 3- to 7-year tenors advanced by 19 to 39 basis points (bps). Beyond the 7-year tenor, yields increased by 40 to 42 bps, with the 10-year tenor closing the month at 1.14%, its highest level since May 2020. Although weekly municipal fund flows remained positive through February, there were hints of a potential end to the nearly year-long inflow cycle in the month’s final weeks, as municipal ETFs and tax-exempt money market funds each reported outflows. $31.5 billion of total municipal debt came to market in February, just a 9% increase over January’s $29.0 billion. However, $11.8 billion of February’s total issuance figure was taxable, representing a 21% month-over-month increase. *

  • While no Federal Open Market Committee (FOMC) meeting was held in February, some Federal Reserve officials commented on the month’s flurry of activity. Fed Bank of Atlanta president Raphael Bostic had this to say on the bond market selloff: “[Long-term bond yields] have definitely moved at the … longer end, but right now I’m not worried about that … I’m not expecting that we’ll need to respond in terms of our policy.” On the overall state of the U.S. economic recovery, New York Fed leader John Williams noted: “Despite the near-term challenges, the longer-term outlook for the economy has improved … [The Fed is] fully committed to supporting the economy through this period.” Mr. Williams also remarked that economic growth in 2021 has the potential to be the “strongest we’ve seen in decades.”
  • As municipal bond yields rose, prices fell and left munis in the red for the month of February. The Bloomberg Barclays Municipal Bond Index returned -1.59% in February, while the Bloomberg Barclays High Yield Municipal Bond Index was down 1.05%. The Bloomberg Barclays Taxable Municipal Index posted a 1.94% loss.
  • Despite falling to historic lows midway through February – the 10-year ratio dipped as low as 54.6% – municipal/Treasury ratios closed the month at higher levels than January. At February month-end, ratios equated to 150% at the one-year tenor (up from 113%), 74% at the five-year tenor (up from 50%), 79% at the 10-year tenor (up from 67%), and 82% at the 30-year tenor (up from 75%).
  • Secondary market trade volume increased by 4.5% in February after a relatively quiet January. February trades totaled nearly 649,000 (up from ~621,000 in January) while par traded amounted to $192 billion (up from $173 billion).

Muni technicals in focus: Fixed income market jitters impact municipals

Rising rate and inflation expectations rattled fixed income markets in February, as the continued vaccine rollout, pent-up consumer demand, and the growing prospect of additional federal stimulus spurred fears of an overheating economy. At its February peak, the 10-year breakeven rate climbed to 2.24%, its highest point since August 2014. Real bond yields surged, as the 30-year TIPS yield climbed into positive territory by mid-month and reached a high of 0.22% – the highest real yield since March 2020. Driven in part by an under-bid 7-year note auction, the 10-year Treasury yield ascended ~40 bps over the month, breaching 1.5% for the first time since last February. With investors scrutinizing inflated valuations – particularly in growth names – equities dipped in tandem with fixed income during the latter half of the month, while commodities rallied on their inflation-hedging properties. Although the Fed attempted to quell concerns, signaling no short-term plans for tapering or monetary tightening, Fed funds futures priced in a January 2023 rate hike by month-end.

For municipals, the first half of the month was largely a continuation of January. Strong demand, coupled with relatively low issuance, continued to push municipal yields downward while municipal credit spreads continued to tighten. By mid-month, the 10-year municipal/Treasury ratio had sunk to a record low of ~54.75%. However, on February 16, municipal yields sharply reversed course and began tracking Treasury yields upward. Municipal yields rose 36-46 bps across the curve, and the 10-year AAA municipal yield closed the month at 1.14%, its highest level since May. Following January’s positive return, the Bloomberg Barclays Municipal Bond Index returned -1.59% in February, the lowest return since March 2020. As municipal credit spreads were stagnant over the latter half of the month, the Bloomberg Barclays Municipal High Yield Index posted a slightly more favorable -1.05% return, its lowest since April.

Despite negative performance, strong municipal market technicals generally persisted over the month. While new issuance of $30.61 billion surpassed last month’s $24.02 billion, supply fell more than $11.5 billion short of last February. Demand remained robust, as retail investors contributed ~$6.22 billion to municipal funds in February, although the final week of the month saw only a $38 million inflow after nine consecutive weeks of $1+ billion inflows. Citigroup projects that municipal reinvestment capital will outweigh new sales by $4.9 billion in March, a noteworthy decline from Citi’s $13.4 billion estimate for February.Although the 10-year municipal/Treasury ratio has risen from its mid-month nadir to ~78.75% at month-end, this figure is reminiscent of levels at the start of the year, and municipal valuations remain elevated relative to Treasuries.

February’s most notable credit event was the severe weather event that hit much of the South and caused widespread damage in Texas. The winter storm appears likely to be the costliest natural disaster in Texas’ history given that all 254 counties in the state were affected, unlike most natural disasters where damage tends to be more localized. We expect the event to have minimal impact on credit quality for Texas municipal issuers given both expected FEMA reimbursement for storm-related expenses and the fact that most high quality local governments in Texas benefit from strong cash reserves and ample margin underneath state-imposed property tax limitations, providing the flexibility to respond to unexpected costs. Additionally, we would expect Texas, with its ample rainy-day fund, to be well-positioned to not only cover its own costs, but to potentially assist other municipal issuers affected by the storms.

The portion of the municipal market that has attracted the most attention following the storm is public power utilities. Texas’ grid operator, the Electric Reliability Council of Texas (ERCOT), was forced to shut down wide swaths of the state’s power grid to protect the system from collapsing, ultimately leaving millions of customers without power for days during frigid conditions. Given the massive imbalance between power supply and demand caused by outages at generators throughout the state, coupled with the storm’s impact on natural gas deliveries, prices on the ERCOT market spiked to $9,000 per megawatt hour from just $30 prior to the event, leaving many utilities with massive bills for purchased power. Notably, these price hikes affected power customers in states beyond Texas. We anticipate high quality utilities will manage through this stress through combinations of utilizing available liquidity, seeking short-term external liquidity such as lines of credit, or even issuing long-term debt to amortize the costs over longer periods. Nonetheless, we continue to closely monitor the sector for potential signs of distress. In the final week of February, we witnessed ratings agencies S&P and Fitch move all Texas utilities that are ERCOT members to Negative Watch, under the expectation that their financial profiles may weaken as they take on additional leverage or spend down available cash. This move increases the probability of downgrades in the near- to medium-term future.

In February, the U.S. House also passed the Biden administration’s $1.9 trillion COVID relief bill, which was signed into law in March. The relief package includes $350 billion of aid to state and local governments, which provides much-needed needed stimulus to issuers throughout public finance and could help stave off a wide array of state and local spending cuts.

Figure 2 shows muni/Treasury taxable equivalent spreads over a five-year period, with spreads tightening across all tenors through January 2021 before widening in February.

Figure 3 is a bar chart showing how yields fared over the past month across the length of the AAA MMD yield curve. Tax-exempt yields were up by roughly 40 basis points from the 5 to 30 year tenors, while taxable yields were up sharply toward the front end of the curve before settling in at an increase of roughly 25 basis points further out.

Figure 4 includes market data as detailed in tables, as of 28 January 2021.

To learn more about investing in municipals at PIMCO, please visit pimco.com/munis



1 Julia-Ambra Verlaine and Sam Goldfarb, “Bond-Market Tumult Puts ‘Lower for Longer’ in the Crosshairs,” Wall Street Journal, 28 Feb 2021
2 Michael Derby, “Fed Officials Upbeat on Outlook, Bond Yield Rise Not Source of Concern,” Wall Street Journal, 25 Feb 2021
3 Thomson Reuters TM3 MMD Interactive Data, 26 Feb 2021
4 Refinitiv Lipper, 24 Feb 2021. *Data is inclusive of weekly reporting funds and does not include monthly reporting funds.
5 The Bond Buyer: Primary Market Statistics – A Decade of Bond Finance, 31 Jan 2021; Bloomberg, 2 Feb 2021
6 Michael Derby, “Fed Officials Upbeat on Outlook, Bond Yield Rise Not Source of Concern,” Wall Street Journal, 25 Feb 2021
7 Bloomberg Barclays, 26 Feb 2021
8 Thomson Reuters TM3 MMD Interactive Data, 26 Feb 2021
9 The Bond Buyer: Secondary Market Data, 2 Mar 2021
10 Federal Reserve Bank of St. Louis, FRED, 10-Year Breakeven Inflation Rate [T10YIE], 1 March 2021
11 Daily Treasury Real Yield Curve Rates, U.S. Department of the Treasury, 1 March 2021
12 Alexandra Scaggs, “Treasury Yields Just Spiked After a Brutal 7-Year Auction. What Investors Should Know”, Barrons, 25 Feb 2021
13 Thomson Reuters TM3 MMD Interactive Data, 26 Feb 2021
14 Bloomberg, 26 Feb 2021
15 The Editorial Board, “Powell Says Full Ease Ahead”, The Wall Street Journal, 24 Feb 2021
16 Bloomberg, 26 Feb 2021
17 Thomson Reuters TM3 MMD Interactive Data, 26 Feb 2021
18 Ibid
19 Bloomberg Barclays, 26 Feb 2021
20 The Bond Buyer, “Bond Sales (Latest Month)”, 26 Feb 2021
21 Refinitiv Lipper, 3 Mar 2021. *Data is inclusive of weekly reporting funds and does not include monthly reporting funds.
22 Martin Z. Braun, “Flows Into Mutual Funds Tumble”, Bloomberg Briefs, Daily Brief: Muni, 1 March 2021
23 Thomson Reuters TM3 MMD Interactive Data, 26 Feb 2021
24 Mitchell Ferman, “Winter storm could cost Texas more money than any disaster in state history,” The Texas Tribune, 25 Feb 2021
25 David Montgomery, Rick Rojas, Ivan Penn, and James Dobbins, “Through Chattering Teeth, Texans Criticize Extended Power Outages,” The New York Times, 16 Feb 2021
26 Selene Balasta, “S&P places Texas-based rural electric co-op on credit watch negative,” S&P Global, 23 Feb 2021; “Fitch Places Texas Public Power Utilities and Electric Cooperatives on Rating Watch Negative,” Fitch Ratings, 24 Feb 2021

Related Funds

Disclosures

Past performance is not a guarantee or a reliable indicator of future results.

A word about risk: Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Income from municipal bonds is exempt from federal income tax and may be subject to state and local taxes and at times the alternative minimum tax; a strategy concentrating in a single or limited number of states is subject to greater risk of adverse economic conditions and regulatory changes. High yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not.

References to specific securities and their issuers are not intended and should not be interpreted as recommendations to purchase, sell or hold such securities. PIMCO products and strategies may or may not include the securities referenced and, if such securities are included, no representation is being made that such securities will continue to be included.

The credit quality of a particular security or group of securities does not ensure the stability or safety of an overall portfolio. The quality ratings of individual issues/issuers are provided to indicate the credit-worthiness of such issues/issuer and generally range from AAA, Aaa, or AAA (highest) to D, C, or D (lowest) for S&P, Moody’s, and Fitch respectively.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice.

Forecasts, estimates and certain information contained herein are based on proprietary research and should not be interpreted as investment advice, as an offer or solicitation, nor as the purchase or sale of any financial instrument. Forecasts and estimates have certain inherent limitations, and unlike an actual performance record, do not reflect actual trading, liquidity constraints, fees, and/or other costs. In addition, references to future results should not be construed as an estimate or promise of results that a client portfolio may achieve.

PIMCO and Gurtin do not provide legal or tax advice. Please consult your tax and/or legal counsel for specific tax or legal questions and concerns. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Any tax statements contained herein are not intended or written to be used, and cannot be relied upon or used for the purpose of avoiding penalties imposed by the Internal Revenue Service or state and local tax authorities. Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement.

Bloomberg Barclays Municipal Bond Index consists of a broad selection of investment-grade general obligation and revenue bonds of maturities ranging from one year to 30 years. It is an unmanaged index representative of the tax-exempt bond market. The index is made up of all investment grade municipal bonds issued after 12/31/90 having a remaining maturity of at least one year. The Bloomberg Barclays High Yield Municipal Bond Index measures the non-investment grade and non-rated U.S. tax-exempt bond market. It is an unmanaged index made up of dollar-denominated, fixed-rate municipal securities that are rated Ba1/BB+/BB+ or below or non-rated and that meet specified maturity, liquidity, and quality requirements. The Barclays Taxable Municipal Index represents a rules-based, market-value weighted index engineered for the long-term taxable bond market. For inclusion in the Index, bonds must be rated investment grade quality or better, have at least one year to maturity, have a coupon that is fixed rate, have an outstanding par value of at least $7 million, and be issued as part of a transaction of at least $75 million. The Intermediate Municipal subsector groups together securities with an average maturity between one to 10 years. The Barclays 1-10 Year Municipal Bond Index is an unmanaged index considered to be generally representative of investment-grade municipal issues having remaining maturities from 1-10 years and a national scope. It is not possible to invest directly in an unmanaged index.

PIMCO as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. It is not possible to invest directly in an unmanaged index. This market update was provided by Gurtin Municipal Bond Management, a PIMCO company (“Gurtin”). This material contains the current opinions of Gurtin and PIMCO. The commentary provided herein represents Gurtin’s assessment of the market environment at a specific time and the opinions and information stated and relied upon herein may become outdated, change, or otherwise be superseded at any time without notice. Certain information contained in this report is based upon third party sources, which Gurtin and PIMCO believe to be reliable, but are not guaranteed for accuracy or completeness. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. ©2021, PIMCO.

CMR2021-0308-1554683

Monthly Municipal Market Update, January 2021
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