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04 August 2020

Weekly Municipal Monitor—Taxable Spread Opportunities Abound

By Robert E. Amodeo, Rolf E. Lundelius, PhD, Sam Weitzman

Muni Inflows Turn Positive for the Year

AAA municipal yields moved 6 bps lower across the curve, trailing Treasuries. Municipal mutual funds recorded a twelfth consecutive week of inflows, turning net flows positive for the year. The Bloomberg Barclays Municipal Index returned 0.36%, while the HY Muni Index returned 0.55%. High-yield muni returns are now flat for the year following declines of nearly 20% in March.

Positive Technicals Persist

Fund Flows: During the week ending July 29, municipal mutual funds inflows were $1.8 billion, according to Lipper. Long-term muni funds recorded $890 million of inflows, high-yield muni funds recorded $181 million of inflows and intermediate muni funds recorded $116 million of inflows. Municipal fund net inflows YTD total $3.1 billion.

Supply: The muni bond market recorded $7.6 billion of new-issue volume last week, down 26% from the prior week. Issuance of $247 billion YTD is 29% above last year’s pace, primarily driven by taxable issuance as tax-exempt issuance is unchanged year-over-year. We anticipate approximately $8 billion in new issuance this week (+5% week-over-week), led by a $1.4 billion LA MTA transaction and a $900 million Taxable State of Hawaii transaction.

This Week in Munis: Taxable Spread Opportunities Abound

Low taxable Treasury rates, and favorable economics for issuers to advance refund tax-exempt municipal debt with taxable issuance has led to heightened taxable issuance. Taxable municipal issuance, inclusive of corporate CUSIPs, reached $91 billion at month-end, according to Bloomberg. This issuance is on pace to double 2019 taxable issuance, which was already at its highest level since the Build America Bonds program.

Exhibit 1: Taxable Municipal Supply
Explore Taxable Municipal Supply.
Source: Bloomberg. As of 31 Jul 20. Select the image to expand the view.

We continue to recognize increased foreign interest in taxable municipals. Low to negative global government interest rates and declining hedging costs have contributed to increased foreign demand of taxable municipals. Moreover, favorable sub-sovereign capital treatment of general obligation bonds, as well as infrastructure qualification for certain revenue liens have also been supportive of foreign bank and insurance demand.

Foreign municipal demand has increased 29% over the last five years to $107 billion, according to the Federal Reserve. As global growth and rates continue to grind lower, we anticipate foreign interest in the municipal bond asset class to persist, particularly given favorable relative valuations versus other fixed-income asset classes despite lower default rates.

Exhibit 2: Bloomberg Barclays Taxable Municipal Bond Index vs Long Corporates Yield-to-Worst
Explore Bloomberg Barclays Taxable Municipal Bond Index vs Long Corporates Yield-to-Worst.
Source: Bloomberg. As of 31 Jul 20. Select the image to expand the view.
Exhibit 3: Municipal Bond Yields and Index Returns
Explore Municipal Bond Yields and Index Returns.
Source: (A) Muni Yields: Thomson Reuters MMD, Treasury Yields: Bloomberg. As of 31 Jul 20.
(B) Bloomberg. As of 31 Jul 20. Select the image to expand the view.
Exhibit 4: Tax-Exempt and Taxable Municipal Valuations
Explore Tax-Exempt and Taxable Municipal Valuations.
Source: (A) Bloomberg, Western Asset. AAA, AA, A, BBB Corporate Indices. After-Tax Yield Assumes a top effective tax rate of 40.8%. As of 31 Jul 20.
(B) Bloomberg, Western Asset, Taxable Muni Index Corporate comparable used is the Long Corporate (ex. BBB) to better align credit quality and duration. As of 31 Jul 20. Select the image to expand the view.