Month in Review

• High yield municipal bonds outperformed investment grade munis in October, although both segments are in positive territory for the year.
• October saw the highest monthly municipal issuance since 2017, as issuers rushed to bring deals to market prior to the election.
• Despite the elevated supply, robust investor demand kept municipal yields contained in October.

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

• The Federal Reserve’s most recent policy meeting fell during the first week of November. Discussion was focused primarily on further methods to support the U.S. economy in the face of increasing coronavirus infections and renewed lockdowns, despite major U.S. stock market indices pushing record highs. Fed Chair Powell noted, “Economic activity has continued to recover… [but] the pace of improvement has moderated.” The Fed reiterated its commitment to provide sustained stimulus as needed, but indicated comfort in current policy and
  guidance.^Footnote5
• New York’s Metropolitan Transportation Authority (MTA) announced plans to tap the Federal Reserve’s Municipal Liquidity Facility for a second time. This time, the MTA plans to borrow all ~$2.9 billion of remaining funds available through the program. With the MLF program set to expire in December and uncertainty surrounding its extension, the MTA is seeking help to cover an estimated $12 billion two-year budget deficit. According to the Authority’s chief financial officer, the MTA would pledge payroll mobility tax revenues.^Footnote6
• Investment grade municipals and high yield municipals moved in opposite directions in October. The Bloomberg Barclays Municipal Bond Index returned -0.30% for the month, bringing its year-to-date total return to 3.02%, while the Bloomberg Barclays High Yield Municipal Bond Index gained 0.18%, bringing its year-to-date total return to 0.54%.^Footnote7
• Following a month in which municipal yields increased across the curve and the Treasury curve experienced a bear steepener, municipal/Treasury taxable-equivalent spreads* increased modestly at the front end and decreased slightly at the long end of the curve in October. At month-end, taxable-equivalent spreads equated to 21 bps at the one-year tenor, 13 bps at the five-year tenor, 72 bps at the 10-year tenor, and 127 bps at the 30-year tenor.^Footnote8
• Secondary market trade activity increased for the second straight month in October, with 679,000 total trades (up from 630,000) and $252 billion par traded (up from $218 billion).^Footnote9

Muni technicals in focus: Munis see record level of pre-election issuance

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