Municipal Monthly

Munis and the Markets, April 2019

A brief monthly update on what's happening in the municipal bond market.

Market Snapshot

The figure is a table displaying return and yield data as of 30 April 2019 for municipal bond markets and U.S. Treasury markets in maturities of 2, 5, 10, and 30 years. It also displays year-to-date data on municipal market issuance, fund flows, and index returns. Key takeaways are discussed in text within the article.

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

The figure is a table showing muni returns for various sectors, for April 2019, 2019 year-to-date, and 2018. Data is detailed within. 

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

The figure is a graph showing muni/Treasury ratios for a five-year period ended in April 2019 for the 10-year and 30-year tenors. The ratio for 10-year tenor fell to about 74%, well below its five-year average of about 90%, and marking a new low for the period. Similarly, the ratio for the 30-year tenor declined to 88%, below its five-year average of about 100%, around its low for the period. The chart also notes how low ratios indicate munis are richly priced, and high ratios mean they’re cheap. 

Municipal Market Issuance

The figure is a bar chart that shows municipal bond issuance by month over the last 13 months. The chart shows April 2019 issuance was $28 billion, up about 5% in March, but down from $32 billion a year earlier. New capital made up about $13 billion of the April 2019 volume, down from about $14 billion in March, versus about $18 billion a year earlier, and marking its lowest point along the 13-month timeline. 

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

PIMCO Muni Highlights

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Disclosures

Municipal AUM cited herein represents assets of the strategy group in dedicated and non-dedicated portfolios. Past performance is not a guarantee or a reliable indicator of future results.

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 the current low interest rate environment increases this risk. Current 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. Investors will, at times, incur a tax liability. Income from municipal bonds is exempt from federal tax but may be subject to state and local taxes and at times the alternative minimum tax.

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 suitable 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.

PIMCO does not provide legal or tax advice. Please consult your tax and/or legal counsel for specific tax or legal questions and concerns.
The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Any tax statements contained herein are not intended or written to be used, and cannot be relied upon or used for the purpose of avoiding penalties imposed by the Internal Revenue Service or state and local tax authorities. Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement.

This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. It is not possible to invest directly in an unmanaged index. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660 | 800.387.4626. ©2019 PIMCO.

Munis and the Markets, April 2019
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