Municipal Bonds: Driven by Technicals
Credit discipline is paramount as technical strength continues to drive the municipal bond market.
Major news headlines’ impact on the municipal market was pacified by persistent low volatility and favorable technical dynamics in the third quarter. Major hurricanes, the potential restructuring of Hartford, budget impasses in Connecticut and Pennsylvania, tensions between the United States and North Korea, uncertainty surrounding the Fed, and the Trump administration’s policy reform efforts have failed to catalyze meaningful price movement in the overall municipal market. Demand for municipal bonds may benefit from domestic tax reform and the global low interest-rate environment. The Trump administration’s initial tax reform proposal, which included the elimination of itemized state and local tax deductions and the alternative minimum tax (AMT), would enhance the relative tax benefits of tax-exempt bonds issued by states with high marginal income tax rates, and nullify the rationale for AMT bonds’ discounts to their respective tax-exempt counterparts. Due to the relative value of tax-exemptions, highly taxed states such as California, New York, and Illinois have become disproportionately represented in the taxexempt municipal market. On the taxable side, the municipal market has seen swelling demand from foreign buyers driven by absolute yield objectives and regulatory changes pertaining to capital requirements for insurers and pension funds. As of Sept. 30, year-to-date supply is down 14 percent over the same period last year, suggesting issuers are apprehensive to come to market ahead of possible federal infrastructure plans. Consistent with past years, we expect supply to wane by the end of the year.
Highly Taxed States Dominate Municipal Bonds Outstanding
Due to the relative value of tax-exemptions, highly taxed states such as California, New York, and Illinois have become disproportionately represented in the tax-exempt municipal market.
Source: SIFMA, Guggenheim Investments. Data as of 10.8.2017.
The Bloomberg Barclays Municipal Bond index posted a 1.1 percent gain during the third quarter of 2017, with longer-maturity bonds continuing to outperform the short-end and lower-quality bonds outperforming higher-quality bonds. BBB-rated and A-rated municipal bonds returned 2.8 percent and 1.2 percent, versus 0.8 percent for AA-rated bonds and 0.7 percent for AAA-rated bonds.
After a record year for new issuance in 2016, municipal bond investors’ insatiable demand has led them to make concessions, while issuers appear to enjoy minimal resistance in capital markets. Several healthcare issuers have successfully refinanced debt with bond documents that significantly weaken covenants or even release collateral at unchanged market levels, despite declining fundamentals. Considering the strong technical demand, we emphasize the importance of credit discipline.
Consistent with Past Years, Supply Is Expected to Decline by Year End
As of Sept. 30, year-to-date supply is down 14 percent over the same period last year, suggesting issuers are apprehensive to come to market ahead of possible federal infrastructure plans. Consistent with past years, we expect supply to wane by the end of the year.
Source: Thomson Reuters, The Bond Buyer, Guggenheim Investments. Data as of 9.30.2017.
—James Pass, Senior Managing Director; Allen Li, CFA, Managing Director
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