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A brief monthly update on what's happening in the municipal bond market.
IMPORTANT NOTICE: Please note that the following contains the opinions of the manager as of the date noted, and may not have been updated to reflect real-time market developments. All opinions are subject to change without notice.
Equities rose modestly in May on signs of economic recovery stemming from the early reopening of cities and states and optimism regarding COVID-19 vaccines in the pipeline. AAA Municipal Market Data (MMD) yields ended May at substantially lower levels than at April month-end. In particular, yields five years and in were down from 70 – 75 basis points (bps) at the end of the month, driving short-term yields close to zero, while yields beyond six years were down between 62 and 65 bps. The 10-year tenor ended the month at 0.84%.1 May total municipal bond issuance of $28.0 billion — approximately $5.3 billion of which was attributable to taxable municipal debt — came in just below April’s final tally of $29.4 billion, marking the second-lowest monthly issuance on the year so far.2
As the nation grappled with reopening from COVID-19 lockdowns and widespread unrest prompted by the death of George Floyd, markets showed signs of emergence during the month of May. Equities continued their upward trajectory, with the Dow Jones Industrial Average and the S&P 500 closing the month over 4.5% higher than last month-end.8 Following two straight months of negative returns for the municipal market, the Bloomberg Barclays Municipal Bond Index returned 3.18% and the Bloomberg Barclays High-Yield Municipal Bond Index returned 4.08% in May, the largest monthly gain since September 2009 for both indices.9
After a net ~$16 billion of municipal outflows last month, investors added net $2.87 billion to municipal funds in May, sending municipal yields plunging.10 From its peak of 2.79% in March, the 10-year AAA municipal yield descended to 0.84% this month.11 The rally was more pronounced on the front end of the yield curve, which was bolstered by support from the Federal Reserve.12 Notably, the Federal Reserve released pricing information for the Municipal Liquidity Facility this month, which was generally more favorable relative to market rates for eligible issuers with lower credit ratings.13 Credit spreads continue to widen, spurred by growing demand for high-quality credits. The BBB - AAA 10-year municipal spread has climbed from 61 bps in mid-February to 146 bps at month-end.14
May brought additional data points on states’ revenue outlooks. April tax revenue numbers showed state tax collection declines of over 25% from April 2019, although some income tax revenue is likely to be recouped as taxes are gradually filed.15 Early indications suggest significant declines in sales tax revenue, including Texas and New York reporting that sales tax revenues fell by 13% and 24%, respectively, from April 2019.16 While we expect continued headline risk, we continue to believe states will close the gaps with a variety of measures, including accumulated rainy-day reserves, spending cuts, federal CARES Act funds, and fund sweeps. California dominated attention with its revised May budget, which projects a $54 billion deficit across fiscal years 2020 and 2021. While the numbers are large, we note that the state faced a $60 billion two-year gap during the financial crisis, with far fewer internal tools available to close the deficit. As we approach July 1, we expect many states will opt to pass placeholder budgets until revenue trends become clearer. While some states such as Illinois and California have proposed budgets that rely on additional federal help, we expect these states to find additional budget solutions should federal support fail to materialize.
The end of May saw the outbreak of widespread protests across a variety of U.S. cities. While this may result in temporary increases in police overtime and public safety expenditures at a time when many local governments are already experiencing revenue losses from the pandemic, we do not expect any material impact on the credit quality of high-quality municipal obligors.17 We feel these obligors have the reserves and financial flexibility to manage through near-term stress. The longer-term impact of possible shifts in public safety and social service spending priorities could present difficult decisions for policymakers, but at this time we do not believe it poses credit risk for investors.
To learn more about investing in municipals at PIMCO, please visit pimco.com/munis
A brief monthly update on what's happening in the municipal bond market.
A brief update on what's happening in the municipal bond market.
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.
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 suitable 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.
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. ©2020, PIMCO.