Municipal Monthly

November Municipal Market Update: Looking Past the Negative Municipal Credit Headlines

Municipal bonds posted their best performance of the year, and we believe municipal credit conditions remain strong.

State revenue trends in focus: While headlines may turn negative, municipal credit conditions remain strong

In recent months, state and local government tax collections have fallen from the exceptionally high and unsustainable levels in fiscal years 2021 and 2022. Total state and local revenue declined 7% in the third quarter from the same quarter last year; however, the overall backdrop remains healthy when put in context. State governments’ fiscal year 2024 budgeted personal income tax collections remain approximately 25% above pre-pandemic levels, sales tax revenues remain relatively stable, property tax trends remain positive, and state and local governments remain flush with accumulated reserves. We expect to see an increase in negative headlines over the coming months as state governments report softer collections relative to prior years – potentially with some falling short of 2024 budget assumptions – but this is likely indicative of a return to a more healthy and sustainable trajectory as opposed to a harbinger of growing credit weakness.

Recent data from California highlights the headline-grabbing revenue declines: California’s October general fund tax receipts missed budget expectations by -31%, with personal income tax (PIT) receipts down -$20 billion relative to budget estimates. This shortfall likely reflects both the shifting revenue environment and the last-minute, one-month extension of the income tax filing deadline. If the October cash report is an early indicator of economic headwinds and a sizeable upcoming budget deficit, we feel California is well-positioned to manage the downturn. Unlike during the global financial crisis, the state is not dealing with a liquidity crisis or governance constraints. Rather, this is a budgetary challenge for which the state has been preparing: California maintains solid reserves and liquidity, and is already operating under a scaled back fiscal year 2024 budget. We would expect the state to respond to an upcoming deficit with austerity measures and use of reserves.

While California was early to make fairly sweeping spending cuts in its 2024 budget, we would note that most large states have dialed back revenue growth estimates considerably for fiscal years 2023 and 2024. Figure 1 illustrates this, specifically showing how a number of states (e.g., Connecticut, New York, and New Jersey) passed budgets that assumed revenue declines and expectations of relatively flat growth in 2024. This is a major positive, as states did not create spending plans for the current fiscal year under the expectation of ongoing robust revenue growth; rather, they were already approaching coming budget cycles with caution. We expect this will make any coming adjustments due to revenue underperformance far easier than if budgets had assumed ongoing revenue growth.

On a broad level, we believe municipal credit conditions remain exceptionally strong. Notably, the median state rainy day fund currently sits at 12% of expenditures versus a median of 4% from 2000 to 2018. Likewise, many local governments are sitting on historically high levels of reserves augmented by remaining federal aid funds that will be spent down through 2026. As negative headlines roll in, it is important to view data in a historical context. We will continue to provide our investors with updates on the municipal credit landscape as it unfolds.

Figure 1 is a line chart showing the annual percentage change in state revenue performance from fiscal year 2018 through the 2023/2024 budgeted fiscal year for California, Texas, Illinois, New York, and New Jersey. Four of the five states reported positive revenue growth in 2018 and 2019, though New York’s revenue fell slightly in 2019. After a mixed 2020, all five states except New York reported positive revenue growth in 2021, led by California at about 25%. After posting solid increases in 2022, led by New York, all five states expect near-zero revenue growth in 2023/2024. Data are based on an internal PIMCO analysis of state audited financial statements and annual operating budgets.

November month in review

Municipal bond performance in November was the strongest of the year to date. The Bloomberg Municipal Bond Index gained 6.35% (3.98% YTD), while the Bloomberg High Yield Municipal Bond Index increased by 7.75% (6.03% YTD), and the Bloomberg Taxable Municipal Index returned 4.95% (3.70% YTD). The most significant gains came at the long end of the curve. Notably, state and local government debt gained more than 5%, the highest figure since January 1986.This robust performance in November turned year-to-date returns in the municipal market positive, highlighting a strong rebound from three consecutive months of negative returns.

As municipals rallied in November, yields dropped across the curve. The 1-, 5-, 10-, and 30-year tenors of the AAA Municipal Market Data (MMD) curve closed the month at 3.00% (-76 bps), 2.59% (-92 bps), 2.63% (-98 bps), and 3.77% (-80 bps), respectively. U.S. Treasury yields similarly fell in November, but at a more modest rate. Yields dropped at all tenors of the Treasury curve, with the 1-, 5-, 10-, and 30-year tenors ending the month at 5.14% (-32 bps), 4.28% (-54 bps), 4.34% (-54 bps), and 4.51% (-51bps), respectively. Performance wise, the Bloomberg U.S. Treasury Index gained 3.47% (0.67% YTD).

As a result of rate movements, municipal/Treasury ratios richened significantly in November. At month-end, ratios at the 1-, 5-, 10-, and 30-year tenors of the curves were 58%, 61%, 61%, and 84%, respectively, compared to October’s month-end figures of 69%, 73%, 74%, and 91%.

Over the first 11 months of 2023, states and localities sold $329.9 billion of long-term municipal bonds, a slight decrease of 2.8% compared to the same time frame of 2022. The small decline was encouraging considering the significant slowdown in overall issuance this year. Notably, the market has seen 28 deals this year exceeding $1 billion, surpassing last year's total of 24 and the previous record of 26 set in 2020. November concluded with total new issuance of $28 billion, down $10 billion from October’s figure but exceeding November 2022’s figure of $26 billion.

November also saw municipal bond trading reach an all-time high of 1.5 million trades, as reported by MSRB, driven by a surge in demand from individual investors. Despite the historically high trading activity, outflows from municipal bond funds continued, bringing the year-to-date total to $18.2 billion. Regardless of fund outflows, we expect ETFs to continue to grow. As experienced last year, tax loss harvesting could drive significant ETF inflows in December.

Figure 2 is a table showing AAA Municipal Market Data (MMD) yields, U.S. Treasury yields, and taxable-equivalent municipal yields as of November month-end, specifically at the two-year, five-year, 10-year and 30-year tenors of each curve. The table shows that AAA MMD yields fell across the curve, declining by as much as 98 basis points in November, while the Treasury yield curve also decreased, but to a lesser extent. Taxable-equivalent yields on AAA municipal bonds ranged from 6.37% at the 30-year tenor, 4.80% for the 2-year, 4.44% for the 10-year tenor and 4.38% for the 5-year tenor in Novemberr. Taxable-equivalent yield assumes 37% federal income tax and 3.8% Medicare investment tax. A separate box below the table includes a few additional data points, such as year-to-date municipal issuance of $350.1 billion, year-to-date municipal fund flows of -$14.4 billion, year-to-date investment grade municipal performance of 3.98%, and year-to-date high yield municipal performance of 6.03%. Data is sourced from Bloomberg, The Bond Buyer, PIMCO analysis of Bloomberg data, Thomson Reuters, and Refinitiv Lipper, all as of 30 November 2023 except for muni fund flows, which are as of 29 November 2023.

Figure 3 is a line graph that tracks the after-tax spread between municipals and Treasuries throughout the period beginning 3 December 2018 and ending 30 November 2023. The average after-tax municipal spread to Treasuries over this five-year period is 41 basis points at the 10-year tenor and 15 basis points at the 2-year tenor. Both the 10-year and 2-year spreads spiked briefly in early 2020, coinciding with the COVID-19 outbreak. At present, the after-tax municipal spread to Treasuries is below the 5-year average for both the 2-year and 10-year tenors. Data is from Thomson Reuters TM3 MMD Interactive as of 30 November 2023. The 2-year and 10-year average spreads were calculated over the last five years, starting 3 December 2018. Data assumes a 37% federal income tax rate and a 3.8% Medicare tax rate.

Figure 4 is a bar graph showing the month-over-month change in AAA MMD yields for both tax-exempt and taxable muni bonds from the 1-year tenor through the 30-year tenor. Yields on tax-exempt munis declined across the entirety of the curve in November. Similarly, taxable muni yields also declined. Data is provided by Thomson Reuters TM3 MMD Interactive as of 30 November 2023.

Figure 5 consists of eight tables. These include municipal index returns, monthly municipal fund net flows, average monthly visible supply, secondary market activity, 10-year municipal vs. 10-year Treasury yields, monthly new issuance, monthly bond redemptions, and sector returns. Sources for the data include Bloomberg, Thomson Reuters TM3 MMD Interactive, Investment Company Institute, PIMCO analysis of Bloomberg data, and The Bond Buyer as of 30 November 2023.


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

Investing in municipal bonds involves the risks of investing in debt securities generally and certain other risks. Investors will, at times, incur a tax liability. 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. 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 increases 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.

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Bloomberg 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 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 Bloomberg 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 Bloomberg 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. The Bloomberg Muni Short (1-5) Index is the Muni Short (1-5) component of the Bloomberg Municipal Bond Index. The Bloomberg U.S. Treasury Index is a measure of the public obligations of the U.S. Treasury. Bloomberg U.S. Aggregate Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. These major sectors are subdivided into more specific indices that are calculated and reported on a regular basis.  It is not possible to invest directly in an unmanaged index.

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