Market Snapshot

Month in Review

• The Bloomberg Barclays Municipal Bond Index returned 0.38% in April, bringing YTD returns to 3.28%. The Bloomberg Barclays Municipal High Yield Index outperformed the investment grade segment of the market, returning 0.58% on the month, driven by positive returns in the tobacco and special tax sectors. This brought returns for the High Yield index to 4.41% on the year.
• Over the month, muni yields rallied on the intermediate and long ends of the curve, with yields falling by between 0 and 5 bps. On the short end, muni yields rose by between 6 and 9 bps. Munis performance was mixed versus the US Treasury Index over the month. Munis outperformed the UST index on the intermediate and long ends, as treasury yields rose over the month. While munis underperformed treasuries on the short end, with yields increasing by a larger margin than treasuries.
• Muni bond mutual fund demand was positive during the month. Lipper reported $6.93 billion in net inflows in April, bringing year-to-date inflows to $29.5 billion. This is the best start to the year since the data series began in 1992, with 16 straight weeks of inflows.
• Muni supply was $28 billion in April, up 5% versus previous the month, but down 12% year-over-year. Despite the muted supply to begin the year, PIMCO expects 2019 supply to be between $350-370 billion, which is an increase of ~4-10% YoY from the $338 billion in supply in 2018. This supply total remains lower than the trailing five year average, which provides a long term tailwind to the muni sector.

Sector Returns

Muni Credit in Focus – Pension Obligations

• As the economy progresses into the later stages of the expansion, concerns over unfunded pension obligations again come to the forefront. Pensions struggled through the burst of the dot-com bubble, when average funded ratios dropped to 85% from 102%. This happened again during the financial crisis of 2008-2009, when average funded ratios for pensions dropped to 72% from 86%. These periods strained municipalities, which had to balance funding basic services and meeting annual required contributions to the pension funds. In the years that have followed, with equity returns fueled by Quantitative Easing, many expected pensions to recover. However, in that timeframe, pension liabilities have increased by 64%, while pension assets have only increased by 30%, resulting in a current average funded ratio of only 68%. Despite the strong economy, pensions are now less funded than immediately after the financial crisis. The pensions are also highly sensitive to market drawdowns, as the Q4 2018 equity drawdown contributed to a 10% drawdown on pension assets, according to Fed Flow of Funds. That drawdown contributed to an aggregate funded ratio drop of 6%, with pension funding going from 51% to 45% in Q4 alone.
• In this late cycle environment, municipalities are facing the threat of lower equity growth along with an aging population. Together, these factors are putting additional pressure on the pension funds of these municipalities. In response to the growing unfunded pension liabilities, some municipalities have considered pension obligation bonds (POBs), designed to quickly fund pensions by creating debt. In general, PIMCO is wary of muni credits using POBs as a resolution, especially in the absence of meaningful reform and so late in the economic cycle. As the economy creeps closer to the next recession, the aforementioned factors could spell trouble for general fund obligations of municipalities with significant unfunded pension obligations. Revenue bonds with secure income streams will be less affected by these issues moving forward, which reaffirms PIMCO’s more constructive view on revenue bonds.

MUNICIPAL/TREASURY YIELD RATIO

Municipal Market Issuance

To learn more about investing in municipals at PIMCO, please visit pimco.com/munis