Munis and the Markets, January 2019

by Team of PIMCO, 2/21/19

SUMMARY

  • We believe the federal tax-exempt municipal market may offer attractive benefits to U.S. investors late in this economic expansion, as we expect municipals to outperform taxables on a taxable-equivalent basis as they have in prior tightening cycles.
  • While the late-cycle performance of municipals has been strong historically, it’s important to consider what might be different this time around. A key shift from past cycles is the sharp reduction in bond insurance on new muni issuance, from over 50% before the crisis to about 4% today. This has, in many ways, transformed the municipal market into a credit market.
  • We expect credit quality to be a key performance driver when the economic cycle turns, making strong research and active selection critical.

Market Snapshot

MARKET SNAPSHOT

Month in Review

  • The Bloomberg Barclays Municipal Bond Index returned 0.76% in January, starting the year on a positive note. The Bloomberg Barclays Municipal High Yield Index underperformed the investment grade segment of the market, returning 0.67% on the month, driven by positive returns in the lease-backed and general obligation sectors.
  • Over the month, muni yields rallied on the front and intermediate portions of the curve, with yields falling by between 11 and 18 bps. Also, munis outperformed the US Treasury Index over the month. However, the MMD/UST ratio performance was mixed, as the 5y and 10y ratios richened by 5% and 2%, respectively, and the 30y ratios cheapened 1%.
  • Muni bond mutual fund demand was positive. during the month. Lipper reported $3.99 billion in net inflows in January, demonstrating strong demand after the period of outflows that ended 2018.
  • January supply was up 20% versus previous month at $24 billion, and up 12% year-over-year. PIMCO expects 2019 supply to be between $350-370 billion, which is an increase of ~4-10% YoY from the $338 billion in supply in 2018. This supply total remains lower than the trailing five year average, which provides a long term tailwind to the muni sector.
  • The longest government shutdown in American history went on for much of January, before President Trump signed off on temporarily funding the government through February 15. Experts say the shutdown will have a small impact on 2019 GDP, but full effects are not yet known.