Munis springing ahead
The calendar leaves much to be desired for investors, as the week only brings $2.4 billion of new deals.
Bank of America Securities research team, led by Phil Fischer, Fixed Income and Muni Strategist, said that munis continue an aggressive rally, with ratios to Treasuries on the curve's long end moving to very rich.
“We do not think this is over since we are heading into tax time and given the State and Local Tax cap is only making munis a more attractive tax haven,” said a new report Monday. “We often talk about seasonality, but now it has a slightly different twist: when this winter ends, the roads across the U.S. are going to start singing ‘fix me’.”
The report continued that the muni market has maintained a strong bid as individuals approach tax time and learn how to spell SALT. Monthly mutual fund inflows are approaching $4 billion. Munis are one of the few remaining to save on taxes and are being bid rich by historical standards as a result. BofA expects the SALT effect to be permanent.
“While infrastructure investment gains notoriety in Washington, D.C., there is very little movement associated with it,” the report said. “At the state level things are different: year-to-date 2019 transportation and general purpose issuance is above that of last year, but it is still not enough. Beyond deferred maintenance, issues related to weather are wreaking havoc on infrastructure.”
Technically speaking, muni volatilities and yields have been decreasing and their risk-adjusted total rate of return is increasing.
“Their volatility is correlated with both the equity and bond markets' volatilities,” the report said. “Munis are showing lower spreads than the regression of spreads based on historical volatilities and, therefore, are trading richer.”
For the fourth year and sixth quarter in a row, Moody's upgrades outpace downgrades. BofA Securities noted that the rating agency upgraded a total of 480 credits versus 392 downgrades.
“Prior to 2015, munis suffered six straight years of downgrades outpacing upgrades,” the report said. “For the fourth quarter of 2018 alone, Moody's upgraded 130 credits versus 84 downgrades — the sixth consecutive quarter where upgrades outnumbered downgrades.”
In a marked reversal from 2017, the par value of upgrades ($99.4 billion) eclipsed that of downgrades ($42.0 billion) with a ratio of nearly 2.4 to 1 — the largest since 2008's ratio of 2.5 to 1 and only the second year in the post-recession era that this has occurred.
“While we saw the same for fourth quarter data, the ratio declined into the quarter from a high of roughly 4.3 to 1 in the second quarter. This may be the result of the benefits of tax reform being front-loaded in 2018.”
Investors constructive on munis
A price rally is keeping the municipal market repositioned for lower interest rates — and potentially lower policy rates — with the backdrop of scarce volume and heavy demand, according to a Northeast portfolio manager.
“We were expecting two to three [hikes] and now we are looking at zero to one so the market has moved accordingly,” he said after describing a typically quiet Monday in the municipal market. He said cash-flush investors were gearing up for the week’s new-issue slate with bated breath.
“People are constructive on munis and that’s going to keep the follow through and demand firm,” he said — despite the lack of activity at that start of the week where rates were unchanged and demand was strong — continuing the year-to-date pattern. “If there’s no movement in Treasury rates, there’s no movement in muni rates, so I would call it a flat day,” he added. “I think when new issues come to market they will do well.".
“There’s lots of cash, but not enough bonds to suffice for the demand,” he continued, noting that recent large new issues have been oversubscribed as a result — and he expects that to be the case later this week as well. Monday’s lack of activity is indicative of a year-long pattern that should continue into the next quarter, the portfolio manager said. “People are waiting for new issues, but today our phones weren’t buzzing,” he said.
Flows and performance
Historically strong year-to-date flows should lead to continued strong performance and increased retail demand, according to BlackRock Inc.’s monthly municipal report.
“We expect demand to remain strong as taxpayers feel the effects of tax reform,” Peter Hayes, head of the municipal bonds group at BlackRock wrote in a report he authored with James Schwartz, head of municipal credit research and Sean Carney, head of municipal strategy.
They said 2019 flows were off to the “best start of any year on record,” judging by data from the Investment Company Institute.
“Municipal bonds forged ahead with a fourth consecutive month of strong performance in February amid favorable supply-and-demand dynamics and range-bound interest rates,” the analysts wrote.
BlackRock oversees more than $129 billion municipal assets.
Referencing the S&P Municipal Bond Index gain of 0.53% over the month, they said that brought the year-to-date return to 1.26%.
Particularly strong returns came from the long end of the yield curve, lower-rated investment grade credits, Puerto Rico bonds, issues in higher-yielding states, such as Connecticut, New Jersey, Illinois, and Pennsylvania, and the utility and healthcare sectors.
Gross issuance was modest at $24.9 billion — 53% higher than the tax reform-driven dearth experienced in 2018 — yet still 2% below the historical five-year average, the analysts said.
“As we projected in our 2019 Outlook, this modest level of issuance has continued to be outpaced by reinvestment income, creating a favorable net-negative supply environment,” they wrote.
With four consecutive weeks of net inflows, the analysts referred to the municipal demand in February as “sensational,” with demand broad-based across sectors — yet particularly strong among long-term municipal funds.
“Although continued strong performance has resulted in fairly stretched relative valuations, especially in the front and intermediate parts of the yield curve, we remain constructive on the asset class,” the analysts wrote.
“We anticipate that issuance will remain manageable and retail demand may strengthen further as investors are likely to place a higher value on the tax advantages of municipal bonds after realizing the disappointing impact of reform during tax season,” they added.
The BlackRock analysts said their strategy and positioning favors a long-uration stance, using a barbell yield curve strategy — focusing on maturities of zero to two years and 20 years and beyond.
“Cash has become increasingly attractive given higher short-term rates, and longer-dated bonds offer the more compelling valuations along the yield curve,” they wrote.
The team is currently overweight in state tax-backed and essential-service bonds, particularly in the Northwest, Sun Belt and Plains, as well as school districts. At the same time, it is underweight in states and local municipalities with poorly funded pensions, such as Illinois, New Jersey, Kentucky, Pennsylvania, and Connecticut, as well as single-site hospitals in Medicaid non-expansion states, speculative projects with weak sponsorship, unproven technology or unsound feasibility studies.
New issuance will be bleak this week, with the Federal Open Market Committee meeting set for later this week.
Although the Federal Reserve has made clear it will hold interest rates for the time being, the panel still has much to discuss, including the end of balance sheet normalization and the Fed's review of how it formulates, conducts, and communicates monetary policy.
A decision on an end to balance sheet run-off and a new Summary of Economic Projections, with lower projections for future interest rate increases, will be the highlights of the March 19-20 FOMC meeting.
Bank of America Securities is expected to price the Indianapolis Local Public Improvement Bond Bank's (NR/NR/AAA) $610.495 million of community justice campus bonds for the courthouse and jail project on Thursday.
Goldman is expected to price the California Educational Facilities Authority's $460 million Stanford University revenue bond transaction.
Piper is scheduled to run the books on Prosper Independent School District, Tx.'s (Aaa/NR/NR) $200.5 million of general obligation unlimited tax school building bonds on Tuesday.
Week's actively traded issues
Revenue bonds made up 55.28% of total new issuance in the week ended March 15, up from 55.10% in the prior week, according to IHS Markit. General obligation bonds made up 39.94%, up from 39.58%, while taxable bonds accounted for 4.78%, down from 5.32%.
Municipal bonds were mostly stronger on Monday, according to the MBIS benchmark scale, with muni yields falling three basis points in the 10-year maturity, while the 30-year maturity saw yields rise by less than one basis point. High-grade munis were also mostly stronger, with the yield falling no more than three basis points in the 10-year and increasing less than one basis point in the 30-year maturity.
Investment-grade municipals were unchanged on Refinitiv Municipal Market Data’s AAA benchmark scale, which showed the yields on both the 10-year and 30-year maturities flat.
The 10-year muni-to-Treasury ratio was calculated at 78.4% while the 30-year muni-to-Treasury ratio stood at 94.5%, according to MMD.
Previous session's activity
The MSRB reported 33,304 trades on Friday on $10.716 billion of volume. California, Texas and New York were most traded, with the Golden State taking 15.877% of the market, the Empire State taking 15.39% and the Lone Star State taking 13.795%. The most active issue was the Metropolitan Transportation Authority 5s of 2022 which traded 94 times on volume of $69,940 million.
Treasury auctions discount rate bills
Tender rates for the Treasury Department's latest 91-day and 182-day discount bills were mixed, as the $48 billion of three-months incurred a 2.410% high rate, up from 2.405% the prior week, and the $39 billion of six-months incurred a 2.450% high rate, off from 2.455% the week before.
Coupon equivalents were 2.465% and 2.522%, respectively. The price for the 91s was 99.390806 and that for the 182s was 98.761389.
The median bid on the 91s was 2.380%. The low bid was 2.360%.
Tenders at the high rate were allotted 79.56%. The bid-to-cover ratio was 2.70.
The median bid for the 182s was 2.430%. The low bid was 2.390%.
Tenders at the high rate were allotted 16.44%. The bid-to-cover ratio was 2.86.
Gary E. Siegel contributed to this report.
Data appearing in this article from Municipal Bond Information Services, including the MBIS municipal bond index, is available on The Bond Buyer Data Workstation. Click here for a brief tour of the Workstation, or contact Ziad Saba at 212-803-6079 for more information.