SUMMARY
- The Bloomberg Barclays Municipal Bond Index suffered its first monthly loss of 2019, falling by 0.80% in September as rates rose across U.S. fixed income markets.
- Retail demand for municipal bond mutual funds has remained robust, though average annual net inflows slowed slightly from the torrid weekly pace in August.
- Monthly municipal bond issuance in September totaled $35.4 billion, surpassing $35 billion for only the third time this year.
Market Snapshot
Month in review
Monthly municipal bond issuance in September totaled $35.4 billion, surpassing $35 billion for only the third time this year. AAA municipal yields rose by at least 17 basis points (bps) across the curve, with the greatest increase of 25 bps month-over-month occurring at the 1-year tenor.1
- On September 18, the Federal Reserve cut interest rates by a quarter point, with Chair Powell leaving the door open to additional cuts but declining to offer assurance. The move marked the Fed’s second such action this summer to aid the continuation of the current expansion. The Fed also injected billions into overnight repo markets starting on September 17 to keep the Secured Overnight Financing Rate (SOFR) in check.2
- The Bloomberg Barclays Municipal Bond Index returned -0.80% in September, as higher yields across the curve resulted in the first month of losses for the broad municipal bond market since October 2018.3
- Muni/Treasury ratios increased across the curve in September. Notably, the two-year ratio moved from 67% to 75%, and the 10-year ratio increased from 81% to 85%.4
- September’s primary market issuance of $35.4 billion represented a 7.9% decrease from August 2019 but a 40.3% increase over September 2018.5
- Secondary market trade volume slowed during September, with par traded totaling just $225 billion and the quantity of trades tallying just 630,000 (down 8.8% and 5.3% from August, respectively). The latter marks the fifth straight month of declining trades.6
Muni credits in focus: uncovering overlooked credit risk
The Bloomberg Barclays Municipal Bond Index suffered its first monthly loss of 2019, falling by 0.80% as rates rose across U.S. fixed income markets.7 Retail demand for municipal bond mutual funds has remained robust, though average annual net inflows slowed slightly from a torrid weekly average pace of about $1.85 billion in August to an average of $1.31 billion in September.8 On the supply side of the equation, new issuance surged to $35.4 billion, which is 40% above September 2018 levels – though we would note that more than half of this increase was driven by issuance of taxable municipals.9 This trend has continued since July, as large issuers, such as the Bay Area Toll Authority, chose to advance-refund outstanding tax-exempt bonds with new issuance of taxable debt.10 We expect technicals to remain supportive in high-tax states, as a legal challenge to the state and local tax (SALT) deduction cap ushered in by the 2017 Tax Cuts and Jobs Act was thrown out of federal court at month’s end.11
The broad muni credit landscape continues to look relatively rosy, with state and local government tax revenues from major sources increasing by 4.2% year-over-year in the first quarter of 2019.12 However, against this positive economic backdrop, idiosyncratic credit stress flared up in two separate instances this month, highlighting the importance of intensive fundamental credit research.
In California, officials of a unified school district were charged by the SEC with defrauding investors by omitting information when the district issued bonds in 2016.13 In Wisconsin, a multifamily housing bond backed by a charitable foundation was downgraded 11 notches to CCC by S&P Global Ratings in one fell swoop.14 We believe both instances illustrate why deep, forward-looking credit research is vital in seeking to protect principal and enabling our team to identify and avoid obligors that we believe are subject to material risks that may be overlooked.
1 Thomson Reuters TM3 MMD Interactive Data. Bond Buyer: Primary Market Statistics – A Decade of Bond Finance, 30 September 2019
2 Nick Timiraos, “Fed Cuts Rates by Quarter Point but Faces Growing Split,” Wall Street Journal, 18 September 2019; Gina Heeb, “The Fed is injecting hundreds of billions into markets - and it's a practice that could become the new normal,” Markets Insider, 30 September 2019; Federal Reserve Bank of New York Federal Funds Data, 30 September 2019
3 Bloomberg Barclays, 30 September 2019
4 Thomson Reuters TM3 MMD Interactive Data, 30 September 2019
5 Bond Buyer: Primary Market Statistics – A Decade of Bond Finance, 30 September 2019
6 Bond Buyer: Secondary Market Statistics, 30 September 2019
7 Bloomberg Barclays as of 30 September 2019
8 Investment Company Institute, 30 September 2019
9 Aaron Weitzman, “Taxable bonds helped issuance soar in September,” The Bond Buyer, 30 September 2019
10 Romy Varghese, “Bloomberg Brief: Muni, Advance Refundings Go Taxable,” Bloomberg, 16 September 2019
11 Chris Dolmetsch and Laura Davison, “SALT Tax-Cap Challenge by New York and New Jersey is Tossed,” Bloomberg, 30 September, 2019
12 Lucy Dadayan, “Turbulence Continues in State Tax Revenues in the First Half of 2019, Largely Related to TCJA Federal Tax Changes,” Urban Institute, September 2019
13 Sarah Wynn, “SEC charges California school district, officials with fraud,” The Bond Buyer, 19 September 2019
14 Danielle Moran, “Bloomberg Brief: Muni, Advance Refundings Fuel Taxable Surge,” Bloomberg, 2 October 2019
DISCLOSURES
A word about risk: Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Income from municipal bonds is exempt from federal income tax and may be subject to state and local taxes and at times the alternative minimum tax; a strategy concentrating in a single or limited number of states is subject to greater risk of adverse economic conditions and regulatory changes.
Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice.
Forecasts, estimates and certain information contained herein are based upon proprietary research and should not be interpreted as investment advice, as an offer or solicitation, nor as the purchase or sale of any financial instrument. Forecasts and estimates have certain inherent limitations, and unlike an actual performance record, do not reflect actual trading, liquidity constraints, fees, and/or other costs. In addition, references to future results should not be construed as an estimate or promise of results that a client portfolio may achieve.
PIMCO does not provide legal or tax advice. Please consult your tax and/or legal counsel for specific tax or legal questions and concerns. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Any tax statements contained herein are not intended or written to be used, and cannot be relied upon or used for the purpose of avoiding penalties imposed by the Internal Revenue Service or state and local tax authorities. Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement.
This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. It is not possible to invest directly in an unmanaged index. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world.
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