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.
Month in Review
Despite closing September several percentage points lower, major U.S. stock indices managed to record sizable gains in the third quarter. Meanwhile, the municipal market was characterized by a continued influx of supply. September’s $47.3 billion in new issuance marked the highest figure for the month since record keeping began in 1986.Footnote1 The increased supply boosted yields on the long end of the AAA Municipal Market Data (MMD) curve, with yields beyond eight years up by 5-6 basis points (bps). By contrast, yields inside of four years came down by 3 bps. One driver of lower yields in short-dated maturities was increased demand for short-duration funds, as market uncertainty prompted more of a risk-off sentiment. The 10-year tenor closed out September at 0.87%.Footnote2 Notably, taxable municipal debt surpassed $100 billion on the year for the first time since 2010, when the Build America Bonds program was in effect. September’s figures brought 2020 year-to-date municipal issuance to $341.8 billion, with taxable issuance accounting for $102.7 billion.Footnote3
- The Federal Reserve expressed its commitment to leave interest rates “lower for longer” following September’s two-day policy meeting. Additionally, revisions were made to the Fed’s trigger for raising interest rates; the Fed will now require evidence of a tight labor market, inflation measures printing at or above 2%, and expectations for inflation to “moderately exceed 2% for some time.” A survey of the 17 Fed officials indicated that 13 expect interest rates to remain near zero through 2023.Footnote4
- Two high-profile municipalities, the State of New Jersey and the New York Metropolitan Transportation Authority (MTA), each expressed considerations to tap into the Federal Reserve’s Municipal Liquidity Facility as a source of short-term liquidity. Such a move would mark the first time that New Jersey moved to tap the facility for borrowing needs. The NY MTA has already tapped the facility once, and additional borrowing would allow it to access the additional ~$2.9 billion made available through the program.Footnote5 Nonetheless, the MLF remains underutilized relative to other Fed facilities and continues to serve primarily as a liquidity backstop.
- Both investment grade municipals and high yield municipals inched up slightly in September. The Bloomberg Barclays Municipal Bond Index returned 0.02% for the month, bringing its year-to-date total return to 3.33%, while the Bloomberg Barclays High Yield Municipal Bond Index gained 0.10%, bringing its year-to-date total return to 0.37%.Footnote6
- Against the backdrop of a steepening municipal curve and a flattening Treasury curve, municipal/Treasury taxable-equivalent spreads* decreased slightly at the front end and increased modestly at the long end of the curve in September. At month-end, taxable-equivalent spreads equated to eight bps at the one-year tenor, 17 bps at the five-year tenor, 79 bps at the 10-year tenor, and 129 bps at the 30-year tenor.Footnote7
- The secondary market was slightly more active in September than in August, with 630,000 total trades (up from 590,000) and $218 billion par traded (up from $202 billion).Footnote8
Muni technicals in focus: Muni yields stay anchored as muni investors show patience
Markets exhibited a modest risk-off tone throughout much of the month, with the ongoing pandemic, fluctuating federal stimulus prospects, and the upcoming presidential election contributing to near-term uncertainty. Although the Federal Reserve signaled that it may hold rates near zero through 2023, investors shifted to safety and the 10-year Treasury yield declined to 0.68% to close the month.Footnote9 10 Often considered a “safe haven”, municipals did not track Treasuries’ course in September. Instead, municipal yields remained largely stagnant over the month, with municipal investors generally curbing duration exposure and awaiting further market developments for clearer signs of directionality. After a relatively notable move on the last day of the month, the 10-year AAA municipal yield rose to 0.87% at month-end.Footnote11
Following last month’s negative return, the Bloomberg Barclays Municipal Bond Index delivered a slight gain of 0.02% in September.Footnote12 In line with seasonal trends, elevated new issue supply outweighed reinvestment capital over the month. Although a net ~$1.34 billion was added to municipal funds this month, 19 consecutive weeks of inflows were reversed at month-end.Footnote13 Meanwhile, on the supply front, monthly new issuance of $47.3 billion was the greatest for a September on record.Footnote14 Taxable issuance comprised $16.0 billion of this total, surpassing last September’s taxable volume by nearly 116%.Footnote15
September also brought some encouraging news about state and local finances. New research released by Brookings found that although state and local governments continue to confront significant revenue losses in fiscal years 2021 and 2022 (cumulatively just over $300 billion), the figures are less than certain earlier projections of more than $500 billion. We have seen a number of states with recent tax collections that are exceeding estimates, although many of these estimates were dialed back considerably months ago as states anticipated deep revenue shocks. While this is good news, we believe that the revenue outlook still suggests a need for additional federal stimulus in order to stave off additional austerity measures to close budget gaps.
Within higher education, preliminary data suggest undergraduate enrollment numbers were down 2.5% relative to the prior fall semester, with community-college enrollment also down sharply.Footnote16 While declines will result in revenue losses for many institutions, we believe it is important to note that the losses are not as steep as many had feared early in the pandemic when worst-case enrollment scenarios were significantly bleaker. Additionally, some institutions have not seen significant declines (public higher education, in particular, saw essentially flat enrollment trends), and we feel a portion of the losses for the sector are likely to prove temporary as many students are merely deferring enrollment until next year. We continue to believe that high-quality universities with strong endowments benefit from both ample liquidity to cushion revenue volatility and strong management teams that responded quickly during the pandemic with cost-cutting measures.
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