The outlook for the municipal bond market in 2016 is positive, even considering credit trouble in Puerto Rico and Chicago, according to John Miller, who manages and co-manages municipal bond mutual funds totaling about $20 billion at Nuveen Asset Management LLC.
Miller, whose responsibilities include the Nuveen High-Yield Municipal Bond Fund, offered his insights in a March 1 video on the firm's website.
Overall, Miller expects stability in key sectors that drive the market, such as the plain-vanilla general obligation and revenue sectors. In addition, he said limited net new supply for infrastructure projects should continue to fuel the solid demand for an asset class that has relatively low volatility and low risk.
While the Federal Reserve Board's long-anticipated rate hike in December was well tolerated by the market, he believes the Fed will fall short of delivering four, quarter-point rate hikes it forecasted for this year.
"The market has essentially priced those out for the year 2016," he said, adding that falling commodity prices and a strengthening dollar are being met by the lack of inflationary pressure and growth at a time when many other major economies, including Brazil and Russia, are in recession.
On the supply front, Miller expects municipal volume to come under $400 billion in 2016 as it did in 2015 – largely due to continued heavy refunding issuance.
As a result, the net additional debt for new infrastructure finance may only grow 1% to 2% this year, Miller projected.
So far, this year's volume is running roughly 7%-8% lower compared to last year – which was the highest issuance in the last five years, Miller noted.
"Most of the new issuance is based on municipalities trying to save money, and calling other bonds and refinancing other bonds," he said.
On the credit front, he said any fundamental challenges in the municipal market remain "episodic and case-specific," pointing to outliers such as Puerto Rico, Chicago, and Chicago Public Schools.
The commonwealth faces a negative $980 million fund balance on top of insufficient funds to pay $2 billion of payments coming due July 1, while unfunded and deferred pensions is further heightening the political and fiscal stress in the city of Chicago and the Chicago Board of Education's public school districts, according to Miller.
A "severe" budget deficit and the lack of a teachers' contract, are two additional pressures facing the Chicago Public School District going forward, he said.
The approval for property tax increases totaling $550 million a year could stoke Chicago's already-strong and diversified economy, Miller said.
Meanwhile, he said Puerto Rico is vulnerable to more fiscal stress as it tries to find restructuring solutions, following December 2015 defaults, he said.
Despite the challenges facing these outliers, the overall municipal market offers "a relatively safe place to hide with the tax-exempt benefits," for fixed-income investors.
He noted that 2015 was one of the lowest for monetary defaults since 2000, and for the first time since 2006, Moody's Investors Service upgraded more issues in 2015 than it downgraded.
Should there be any uptick in defaults in 2016, Miller said he expects those to stem from Puerto Rico.
"Fundamentally, we're actually seeing good stability in key sectors that are bigger drivers of the muni bond market," Miller said.
He said municipals have a "low correlation to some of the more volatile asset classes that investors are exposed to."
"We expect demand to be stable and the asset class should have a coupon plus some mild potential for capital appreciation for the year," Miller said.
