Interest-Sensitive? Let Us Count the Ways
September 20, 2016 10:43 AM
The Federal Open Market Committee meets today, eight years after the financial crisis prompted policy makers to set the target rate near zero. Historically low interest rates since then have led to a range of reactions in the municipal bond market. Bond Buyer prepared charts of key interest rate related metrics and asked municipal analysts and strategists to identify the biggest impact of the prolonged cycle of low interest rates as policy makers refrained from further action after a December 2015 rate increase.
Jeffrey Lipton, Oppenheimer & Co.
Throughout 2016 year-to-date, strong demand for the municipal asset class has been the dominant story. The demand and resiliency for municipals is illustrated by the [50] consecutive weeks of positive mutual fund flows that have shown cash additions largely accelerating week to week. It is this strong demand that has resulted in a year-to-date total return of about 4.5%. Year-to-date, the muni market has posted 13 consecutive months of positive performance as investors continued to clip their coupons and benefitted from the carry. "
Alan Schankel, municipal strategist at Janney Capital Markets
I think the noteworthy takeaway on the muni market since the December hike is the unrelentingly positive fund flows, which seem to belie investor concerns about potential for longer term rates to rise, even if the Fed bumps short rates.
Municipal bond funds have reported a record straight 50 straight weeks of inflows, as investors seek tax free yields in the low interest rate environment. Investors from abroad, seeking an alternative to negative rates, have driven this years surge.
Sean Carney, head of municipal strategy at BlackRock Inc.
The December 2015 hike at the time was viewed as one in a series, however, as the calendar turned and GDP contracted, the one and done nature of the hike, that not only pulled rates lower, but also flattened the yield curve significantly. The inconsistent nature of incoming economic data, as well as headwinds from overseas, made it clear that the Fed would be on-hold, thus, munis benefited from their low volatility characteristic, as well as acting as a diversifier away from equity and equity-like risk. The realization that income and carry would continue to be a winning strategy stoked investor demand for municipals that has continued well into 2016.
U.S. economic growth has been in slow-growth mode for most of the period.
Peter Block, managing director at Ramirez & Co.
Investor reactions have been the biggest impact. Global interest rates went negative in some cases, conflicting opinions of Fed governors. The MMD term spread has flattened 60 basis points since Jan. 1 and Treasuries have rallied similarly. The market is basically telling the Fed, we dont quite believe you anymore, so some investors are not afraid to go out long while others continue to remain cautious and have shortened effective duration to reduce risk.
Muni yields have declined with interruptions in 2011, after banking analyst Meredith Whitney predicted a wave of municipal defaults, and in 2013, as the Jefferson County and Detroit bankruptcies stirred credit concerns.
Bond insurers have struggled to rebuild market share after losing their triple-A ratings during the financial crisis. Expectations that the December rate increase would be the start of a return to normal interest rates -- making it easier to price the insurance product -- havent panned out.
Jim Grabovac, investment strategist at McDonnell Investment Management
Its the dog that did not bark. The Fed engineered a well-telegraphed 25 basis point boost last December while guiding market participants to expect four more hikes in 2016. In terms of the direct impact on the municipal market, it has been scant; and in terms of the indirect impact, declining yield has paradoxically dampened muni supply -- or at least has limited refunding issues -- as the low level of short-term Treasury yields has rendered a significant amount of older, new money deals not eligible for refunding due to negative arbitrage.
Richard Ciccarone, president and CEO of Merritt Research Services
One of the most surprising developments is that new-money issuance for long neglected infrastructure financing hasnt gained more ground given the historically low borrowing rates. More than likely, borrowers dont feel the urgency to issue debt to beat any significant interest rate spikes. For others, there is a bias to shore up the balance sheet rather to issue new debt. The demand for tax-exempt municipal bonds and the relative safety of most investment-grade borrowers has outweighed the negative news associated with the default in Puerto Rico, a scattering of troubled headline credits, and worries about pension liabilities in general.
Refunding volume has overtaken new money deals, as issuers took advantage of the extended opportunity to lower borrowing costs and political pressure curbed infrastructure spending.
John Donaldson, director of fixed income at The Haverford Trust Company
The most notable market force has been the continued imbalance between supply and demand. July and August will have negative supply; that is if the total of proceeds from maturities and calls exceeds new issuance. In almost all cases, investors cannot replace the yield without taking significantly more risk. We originally projected that market yields might be equal to what is being lost by the end of 2016. Now, we cannot see that happening until late 2017 at the earliest.
Dawn Mangerson, director of municipal portfolio management at McDonnell Investment Management.
We have seen continued interest in the muni market with positive inflows for [50] consecutive weeks its welcome, but surprising that its lasted as long as it has in a low-rate environment. In a rallying Treasury market, munis tend to lag, but this year they kept pace with Treasuries, so that is a surprise. Its more of a surprise because after we were expecting more of a hike, and that didnt come to fruition, we reversed course and munis outperformed in that two-year part of the curve.
John Mousseau, director of fixed income at Cumberland Advisors Inc.
I dont think the Fed rate hike or lack thereof since has moved the market one way or the other. The market has moved as we have stayed in a liquidity trap.
