Municipal Monthly

Munis and the Markets, December 2017

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

Market Snapshot

Month in Review

  • Municipals posted strong returns to end the year. The Bloomberg Barclays Municipal Bond Index returned 1.05% in December, bringing its full year return to 5.45%. High yield municipals again outperformed; the Bloomberg Barclays High Yield Municipal Index returned 1.30% during the month and 9.69% for the year.
  • The municipal yield curve flattened during the month, continuing 2017’s overall trend. The very front-end moved higher as the Federal Reserve increased its policy rate by a quarter point - its third hike in 2017. Intermediate and long municipal rates moved lower, however, and outperformed like-maturity Treasury rates.
  • Tax reform took center stage, and President Trump wrapped up this major legislative victory just in time for the holidays. The sweeping tax overhaul moved quickly through both chambers of Congress after the House and Senate drafted amended versions from the separate ones each had previously passed. The municipal market rallied as details of the final bill emerged and were largely viewed as favorable for the market.
  • Key provisions of the tax bill include a significant drop in the corporate tax rate (from 35% to 21%), a lower top personal income tax rate (from 39.6% to 37%), the elimination of most state and local tax (“SALT”) deductions, and the restriction on municipal issuers’ ability to advance refund their debt in the tax-exempt market.
  • Uncertainty over the final tax bill contributed to a steep spike in municipal issuance. December’s $64 billion of supply set a record for one-month issuance. Total year supply ended at $439 billion, just shy of 2016’s record level.

Sector Returns

Policy in Focus: Municipal Supply

  • December’s $64 billion of supply surpassed the previous record level set in December 1985 – not surprisingly, that record was set just ahead of the 1986 Tax Reform Act. December saw a spike in advance refunding and private activity bonds, as both of these looked to be on the chopping block given tax reform. While the final legislation left private activity issuers untouched, the initial House bill would have prohibited tax-exempt issuance by 501(c) organizations like hospitals and universities; many such issuers pulled forward financing given the uncertainty.
  • As a result, we expect 2018 municipal supply to be significantly lower than the past few years. Refunding activity has made up a majority of issuance since 2012, as low interest rates have encouraged municipalities to refinance debt. Advance refundings, where municipalities refinance prior to a call date, accounted for 22% of overall issuance in 2017. The elimination of this option should lead to lower overall supply in the years ahead. This technical support should be favorable for muni market valuations over the cyclical horizon.

Municipal/Treasury Yield Ratio

Municipal Market Issuance

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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 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. Income from municipal bonds may be subject to state and local taxes and at times the alternative minimum tax.

The Bloomberg Barclays Municipal Bond Index is a rules-based, market-value-weighted index engineered for the long term tax-exempt bond market. The Bloomberg Barclays High Yield Index is an unmanaged market-weighted index including only SEC registered and 144(a) securities with fixed (non-variable) coupons. The Bloomberg Barclays High Yield Municipal Bond Index is a rules-based, market-value-weighted index that measures the non-investment grade and non-rated U.S. tax-exempt bond market. It is not possible to invest directly in an unmanaged index.

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