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A brief monthly update on what's happening in the municipal bond market.
In the final weeks of October, major U.S. stock indices tumbled on election uncertainty, rising coronavirus infections, and renewed lockdowns. By month end, the S&P 500, DJIA, and Nasdaq Composite were all down more than 2%.Footnote1 Meanwhile in the municipal market, elevated supply of both tax-exempt and taxable municipal debt remained the primary story as issuers rushed to pull forward deals that would typically come to market in November during a non-election year. In total, October brought $65.2 billion of new issuance to market – the highest monthly figure since December 2017.Footnote2 As a result, municipal yields, represented by the AAA Municipal Market Data (MMD) curve, shifted upward across the entire curve. Yields inside of 10 years increased from 4-9 basis points (bps), while yields beyond 10 years closed the month up by 8-9 bps.Footnote3 After weeks of steady supply in the primary market, however, 30-day net supply is set to turn negative, with maturities far outstripping new supply as we head into the holiday season.Footnote4
Markets reflected optimism to start the month in light of positive economic data and revived stimulus prospects, driving Treasury yields upwards.Footnote10 However, the outlook largely shifted during the latter half of the month, with the U.S. election approaching and states reporting record numbers of daily new COVID-19 infections.Footnote11 The Dow tumbled over 6% during the final week of October for both its worst week and month since March.Footnote12 In only three trading days, the VIX catapulted from roughly 27.5 to over 40 – roughly double the index’s long-term average.Footnote13 Anticipating heightened uncertainty, municipal issuers pushed to bring deals to market ahead of the election. With $65.20 billion in total new issuance, about one-third of which was taxable, October saw the second highest monthly municipal volume on record.Footnote14
Despite the surge in supply, municipal yields did not move drastically during the month as demand remained robust. Retail municipal investors absorbed the elevated supply, pouring net $3.5 billion into municipal funds in October.Footnote15 With municipal yields generally tracking Treasuries’ upward trajectory, the Bloomberg Barclays Municipal Bond Index posted a negative return of -0.30% in October.Footnote16,Footnote17 Notably, while Treasury yields remained elevated at month-end – perhaps due to the perceived higher likelihood of stimulus following the resurgence in cases – the 10-year AAA municipal yield dipped to 0.93% to close the month.Footnote18
Though many state and local government budget forecasts continue to project sizable budget gaps for 2021 and 2022, which we believe are likely to result in significant spending cuts absent additional federal aid, we do continue to see evidence of stability in parts of the market. For example, October brought news of surprising strength in the housing market, with the Case-Shiller Index climbing more than 5% from 2019 levels, despite the pandemic, and the Federal Housing Finance Agency reporting monthly growth in housing prices hitting nearly 30-year highs.Footnote19
These trends should bode well for property tax collections, which are the primary revenue stream for local governments. On a granular level, October brought mixed news for high-profile issuers. We have seen some governments’ revenue collections beat their forecasts (for example, California reported revenues for the first three months of its fiscal year running approximately 15% ahead of budget). However, we continue to see a difficult road ahead for many larger urban governments, with Chicago releasing a 2021 budget in October that seeks to close an estimated $1.2 billion gap through a mixture of tax increases and deep spending cuts. Chicago and New York City were placed on negative outlook and downgraded by rating agencies, respectively, in October, and we anticipate downgrade risk to continue for many larger issuers disproportionately affected by diminished tourism, business activity, and event-related income.
October also brought a reminder that the pandemic may result in prolonged revenue concerns for corners of the market, as we saw a sustained rise in hospitalizations and positivity rates in many states. We believe the risks posed by new waves of the pandemic highlight the need for ongoing stress testing and thorough analysis of individual credits.
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.
Municipals ended the year with their strongest two-month performance since 1986; yields remain attractive.
Municipal bonds posted their best performance of the year, and we believe municipal credit conditions remain strong.
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.
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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.
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