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U.S. Muni Market: Municipal Bonds Bid Well in Risk Averse Environment

By:

Senior Market Analyst at Interactive Brokers

City of Charlotte, NC on Tap with ~US$1.24m GOs

Fixed income investors generally remain attracted to municipal debt, as issuers continue to tap the market, amid consistently positive net inflows and decent annualized returns.

While prices of U.S. Treasuries have since fallen somewhat, recent risk aversion triggered by the novel coronavirus had spurred a plunge in interest rates, as market participants widely conducted flight-to-quality buying, supporting positive total returns for many fixed-income asset classes.

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Nuveen analysts Bill Martin and John Miller observed that returns on taxable municipal bonds (1.71%) and investment-grade corporate debt (1.06%) each outperformed U.S. Treasuries (1.03%) in the week, while munis, in general, “continue to be very well bid in this environment.”

Among the recent deals, the University of Houston System (UHS) sold nearly US$325m worth of ‘AA’-rated debt for new project financing, as well as funding capitalized interest, refunding existing bonds, and paying issuance costs.

Nuveen noted that the deal was priced with a ‘volatile’ versus defensive coupon structure, with the offering’s 30-year bonds sold as 3% coupons at a 2.75% yield. Martin and Miller added that this is “yet another example of investors buying bonds offering the largest tax-exempt income return, regardless of how these bonds may react in a market sell off.”

For the week ended January 29, Refinitiv Lipper U.S. Fund Flows posted net inflows into muni bond funds (for the 56th straight week) of around US$1.74bn, while their four-week moving average is closing-in on the US$2.0bn mark.

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Also, prices of certain exchange-traded funds (ETFs), such as the iShares National Muni Bond fund (NYSEARCA: MUB) and the Vanguard Tax-Exempt Bond fund (NYSEARCA: VTEB), have been holding onto recent gains. The funds have increased by roughly 8.2% and 5.89%, year-on-year respectively.

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Meanwhile, the yield on the U.S. Treasury 10-year note plummeted around 37 basis points from its 1.88% high at the start of January to trade at 1.51% at month’s end. In fact, parts of the yield curve have recently inverted, with other portions flashing potential recessionary warning signs.

In late January, for example, the yield on the 5-year note had inverted with the 2-year by around 1-2 bps, while the 10-year note’s spread to the 2-year collapsed by as much as 14 bps over the course of the month to come within about 16bps of inversion.

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Briefing.com’s chief market analyst Patrick O’Hare recently noted that each of the past five recession periods since 1980 were preceded by an inversion in the 2y/10y spread. He pointed out that “the time between the first inversion and the start of the eventual recession averaged just over 18 months, with a range that spanned from ten months to two years.”

In intraday trading Thursday, yields on the 2-year, 5-year and 10-year U.S. Treasury notes were last bid at roughly 1.451%, 1.466% and 1.651%, respectively, as coronavirus contagion fears eased somewhat, optimism about interest rate cuts from the Federal Reserve in 2020 increased, and risk appetite generally returned to the market.

Supply

Against this backdrop, issuers of municipal bonds continue to churn out new deals.

In January, new issuance volume tallied just north of US$30bn, with Barclays’ strategists highlighting net issuance in the area of +US$9bn. However, they attributed most of that total to taxable municipal deals given the increased supply.

Barclays also expects municipal bond sales in February to come in at around the month’s US$27bn average, driven in part by an uptick in taxable supply “as issuers look to take advantage of the lower rate environment.”

In the meantime, market participants have spotted around US$8.5bn of fresh sales on the near-term radar, after a total of a little more than US$8bn priced in the past week.

Charlotte’s Debt

Among the deals in the pipeline, the City of Charlotte, North Carolina, is set to sell close to US$124m worth of general obligation (GO) refunding bonds, including more than 75.5% worth of taxable issuance.

Moody’s Investors Service, S&P Global and Fitch Ratings each assigned its pristine ‘AAA’ credit rating on the deal, which is being jointly lead-managed by J.P. Morgan and PNC Capital Markets.

For its part, Moody’s said it based its rating on the city’s position as a regional economic center, with “significant tax base and population growth, average income levels and a sound financial position.” These factors, Moody’s said, are supported by “high reserve and liquidity levels.” Furthermore, the agency’s ‘Aaa’ rating also incorporates the city’s “elevated fixed costs,” including debt and pension expenditures.

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Moody’s further said its ‘stable outlook’ reflects “the likelihood that the city will maintain its position as a regional economic center,” as well as maintain its “stable financial position, supported by a trend of operating surpluses.”

The Charlotte City Council noted that its regional economy, as measured by GDP, has grown at an average annual rate of about 3.4% since 2011, which is higher than the national and state annual average of around 2% over the same period.

Between 2008 and 2018, the Charlotte region contributed 53% of the employment growth in North Carolina, with the number of people employed in the city and county up about 2.5% year-on-year in February 2019, with unemployment at a record low of 3.9% over the same period.

According to the Bureau of Labor Statistics, the Charlotte-Gastonia-Rock Hill, NC-SC region experienced a 3.1% unemployment rate in December 2019.

Meanwhile, the Council voted in mid-June 2019 to adopt a US$2.6bn budget for FY 2020, which went into effect July 1.

The FY 2020 budget includes several wage growth-related initiatives, such as: an increase in the minimum wage of full-time City of Charlotte employees to US$16 per hour; additional 5% pay increases for all police sergeants and ‘top-step’ police officers; as well as a 2.5% pay raise for all fire captains and ‘top-step’ fire engineers. 

The Council also has a focus on certain sustainability-related projects.

It highlighted that through its FY 2020 budget, it has helped increase opportunities for the city’s Minority Women Small Business Enterprise (MWSBE) by providing an additional US$450k for capacity building programs, as well as established an Office of Equity, Mobility, and Immigrant Integration to “advance upward mobility, immigrant services, diversity, equity, and inclusion within our organization and throughout the community.”

The deal is expected to close/settle on or about March 4, 2020.

In the meantime, use the global bond scanner in the IBKR Trader Workstation to locate corporate bonds that are available to trade in the secondary market, along with U.S. Treasuries, municipal bonds, non-us sovereign debt and more.

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Disclosure: Interactive Brokers

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Disclosure: Author Security Holding: No Positions

The author does not hold any positions in the financial instruments referenced in the materials provided.

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