The month of March was quiet in muni and fixed income land. Interest rates were virtually unchanged and the range of changes during the month were small at +/-10 bps. Munis are doing a good job of navigating a tough seasonal time of year, and a 10.6% drop in issuance has helped. If issuance does not pick up in the next 30 days, and concerns we had for 2017 continue to move the way they are now, we can see munis putting in a good performance this summer. We encourage investors to be looking to put cash to work over the next 30 days, as good value deals are priced.
As 2017 began, the market had many concerns about a Trump Presidency; we labeled the concerns “Gray Swans”. Although we are only 2 months into the new administration, we feel the market has a better grasp on what to expect from Trump, going forward. Tax reform and infrastructure programs do not appear to be the initial concern that the muni market thought it was. We review in this month’s credit report where we see these Gray Swans migrating over the rest of the year, and how we think it may lead to a good 2017 for munis.
Muni Market Review:
The month of March was very quiet for the fixed income markets. Yields were virtually unchanged and moved +/- 10 bps during the month even though the Fed raised rates 25 bps. Highlights from a quiet March are as follows:
- Muni rates changed from +5 to -1 bps, with the 5-year being the biggest underperformer.
- Taxable rates changed +0 to +1 bps.
- On the short-end of the market, the increase in fed funds caused the 1-month Libor to increase 20 bps, while the muni 7-day Muni PSA rate went up 29 bps. Some of this increase in the muni rate is also due to seasonal factors.
Other March Muni Market moments:
- To date, 2017 issuance is starting to lag 2016’s record levels. Refunding volume is down a bit, due to the rise in interest rates causing overall issuance to be down 10.6% year-to-date, and 27% versus March 2016. This lower level of issuance is helping the muni market navigate a usually tough seasonal time of year without a negative impact on yields.
- S&P released it default stats for 2016. The overall number of S&P rated public finance issuer defaulting was 15 for a default rate of .07%, up from 2014’s .04%. Of the 15 defaults in 2016, 13 of them were from Puerto Rico issuers, leaving an amazing 2 other issuers. Muni credit quality remains top tier!
We still encourage investors to continue to look for good value bonds to put cash to work over the next 30 days, and/or identify prerefunded bonds that can be sold for income enhancement trades.
Market News & Credit Update:
A recent analysis by Bank of America/ Merrill Lynch shows that munis are a great diversification tool. Municipal bond correlations versus other asset classes for total returns and volatility range from 61% to 26%. This makes munis more appealing from a wealth management perspective and identifying allocations to different asset classes. Highlights of the correlation of total return volatilities are:
- Five year US Treasuries is 35%
- A Five-year US High Yield bond is 29%.
- Five year US Mortgage bonds is 60%
According to the US Census Bureau data, total state and local government tax collections increased 2.5% in the fourth quarter of 2016. Alaska, Washington, Utah, Louisiana, and Florida were the five highest tax collection growth states, with North Dakota, Wyoming, Delaware, Illinois, and Montana the lowest growth states.
Has the credit improvement of the state of California come to an end? Many industry analysts believe the state has reached its credit quality max at AA-/Aa3. The top 1% of earners in the state pay nearly half of the state’s personal income tax collections. A sell off in the stock market or a slowing of the economy will cause a quick and sharp reduction in state revenues.
Moody’s has lowered the rating on the state of New Jersey to A3 from A2 as a swelling pension-fund shortfall and recently enacted tax cuts increase financial pressure on the state. Only Illinois is rated lower than New Jersey.