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U.S. Muni Market: Supply Surge Set to Keep Muni Costs Manageable

By:

Senior Market Analyst at Interactive Brokers

UTA Eyes a ‘AA’-Rated, Taxable Bond Sale

Municipal bond investors have been generally challenged by wild swings in U.S. interest rates, as global headwinds have fluctuated and developments in the domestic economy have sent mixed signals.

The yield on the 10-year U.S. Treasury note was last bid at around 1.78% after having fallen around 7 basis points week-over-week Friday.

A host of market-moving events crossed the newswires throughout the week, including the Federal Open Market Committee’s (FOMC) decision to slash the target range for the federal funds rate by another 25bps – its third cut in 2019 – to 1.50%-1.75%.

The reduction was made on the back of “weak” business fixed investment and a rate of inflation that has been running below the central bank’s 2% target.

Fed chair Powell said that the committee views “the current stance of policy as likely to remain appropriate as long as incoming information about the economy remains broadly consistent” with its outlook. Overall, he added, “we’ve seen moderate growth, a strong labor market,” and inflation “moving up,” amid an outlook that is “for more of the same.”

Further strength in domestic employment was unveiled ahead of the weekend, after the U.S. Bureau of Labor Statistics (BLS) added a total of 128k jobs in October – far more than expected – with another 95k in total upward revisions for the prior two months.

Among other updates for the U.S. labor market in October, the unemployment rate held near a 50-year low at 3.6%, the participation rate climbed 0.1% from the prior month to 63.3% — its highest level since June 2013 – and average hourly earnings (AHE) for private sector workers notched-up by 0.2% over September for a 3.0% year-on-year gain.

Jefferies chief financial economist Ward McCarthy noted that the details of the household survey were “rock solid” and continue to improve at “an astounding rate.” He added that the employment data “is always more compelling when both the establishment and the household survey tell a similar story,” and both surveys “tell a very positive story.”

Manufacturing Sector Betrays Labor Market Strength

Although most details of the BLS employment situation report for October resonated with strength, a total of 36k manufacturing jobs were shed in the latest month, underscored by 42k fewer persons employed in motor vehicles and parts — primarily a reflection of strike activity at General Motors (NYSE: GM).

A lower employment count in the domestic industrial sector also falls in-line with broader deterioration in manufacturing activity.

Indeed, production capabilities have not maintained the same level of improvement or resilience as the U.S. labor market, as illustrated by the Institute for Supply Management’s (ISM) figures for at least the past three months.

ISM noted that economic activity in the manufacturing sector contracted for the third straight month in October, albeit at a somewhat slower pace than in September.

Timothy Fiore, chair of ISM’s manufacturing business survey committee, said that global trade “remains the most significant cross-industry issue,” with food, beverage and tobacco products continuing as the strongest industry sector, while transportation equipment remains the weakest. Overall, Fiore added sentiment in October “remains cautious regarding near-term growth.”

The October PMI came in at 48.3, an increase of 0.5 from the September reading.

Against this backdrop, analysts at Janney Montgomery pointed out that “because the October ISM reading, which stayed at contractionary levels, showed a slight rise from September’s reading, and because earnings season has been a mixed positive,” U.S. Treasuries sold off on Friday to “offset partially the prior day’s rally.”

However, Janney added that while the yield on the 2-year note closed the day 3 bps higher and 10-year yields ended up 2 bps on the day, U.S. Treasuries finished the week stronger, with yields 7 bps to 10 bps lower and the yield curve steeper.

‘Sticker Shock’

Meanwhile, prices of munis have generally risen alongside U.S. government notes, while supply and demand dynamics in the municipal bond market have remained largely intact.

For the week ended October 30, Thomson Reuters/Lipper U.S. Fund Flows posted net inflows into muni bond funds (for the 43rd straight week) of around US$922m, down only slightly from the prior week’s US$1.2bn and just south of their weekly average of US$1.13bn since August 7, 2019.

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 risen roughly 10.37% and 8.52%, respectively, since their most recent 52-week lows set in early November 2018. However, prices of these ETFs have been trending somewhat lower in recent weeks.

Recently priced deals include Broward County, Florida’s airport system revenue and revenue refunding bonds, which sold at yields of between 1.34% and 3.48%; a total of more than US$910m worth of New York general obligation taxable refunding notes, which sold at yields of between 1.8% and 3.29%, and almost $420m of Lehigh County, Pennsylvania General Purpose Authority notes, which priced to yield between 1.33% and 3.38%.

Barclays strategists noted that although municipal fund inflows have stayed “consistently strong over the course of the year, and are in record territory, the going will get harder for munis as rates declined.” They highlighted that when rates fall, “there is always a ‘sticker shock’ for investors,” and, at least initially, tax-exempts “lag during Treasury rallies.”

Prices of tax-exempt munis ended higher this past week by around 3 bps to 4 bps.

Barclays continued that municipal performance is seasonal, and nearly every year there is a year-end rally, which starts in mid- or late-November. However, it is “a little too early” to tell if this rally has already begun, they added, “as supply will likely remain robust in the next several weeks on pace to yet another strong issuance month in November.”

A total of US$9bn worth of new issuance priced in the past week, a drop of US$5m from the prior week’s slate. Year-to-date, supply tallies roughly US$325bn, with net issuance at around -US$1bn.

Market participants place new supply in the week ahead in the range of between US$10bn to US$15bn, with a healthy fraction as taxable transactions.

UTA’s Proposed New Issuance

Among the deals on the near-term radar, the Utah Transit Authority (UTA) is poised to price almost US$60m worth of sales tax revenue bonds (Series 2019A); over US$303.6m worth of federally taxable sales tax revenue refunding bonds (Series 2019B); and a little more than US$148m of federally subordinated sales tax revenue refunding bonds (Series 2019).

UTA said it intends to peg proceeds from the ‘AA’-rated notes in large part to finance certain transit-related projects (Series 2019A), as well as refund certain existing senior and subordinated sales tax revenue bonds (Series 2019B and Series 2019).

The Utah-based authority, incorporated in 1970, owns and operates a mass transit system, which covers a 1,400 square mile service area, within what is commonly referred to as the Wasatch Front.

The authority estimates that population in its coverage area totals roughly 2.5m, which comprises around 79% of the state’s total residents, while ridership on its buses, light and commuter rails, and paratransit/vanpools amounted to 44.2m in 2018.

UTA also noted that it receives its revenues from certain sales and use taxes, fareboxes, and other miscellaneous income, with sales tax receipts in fiscal year 2018 having peaked at a record high of US$273m, up 6.3% from the prior year.

Moody’s Investors Service, which assigned ‘Aa2’ credit ratings to the Series 2019A and Series 2019B notes, and an ‘A1’ rating to the Series 2019 bonds, noted that the senior and subordinate debt is secured by a first and second lien, respectively, on sales taxes collected in the greater Salt Lake City area.

Moody’s analyst Marcia Van Wagner said that the rating on the senior lien bonds reflects “adequate bondholder protections,” including a 2x additional bonds test, peak debt service coverage – “which is strong but somewhat low for comparably rated bonds” — as well as the size and diversity of the service area’s economy.  She also attributed the rating to “recent growth in pledged sales tax revenues, and the absence of significant future borrowing plans.”

Van Wagner added that the rating on the subordinate lien bonds “reflects the significantly more narrow coverage for the subordinate debt, and a relatively low 1.2 times additional bonds test.”

Overall, Moody’s attributed the stable outlook on the notes to “healthy recovery in sales tax revenues following a period of recession-driven declines and stagnation, and the expectation that peak coverage levels will improve in the near term.”

The issuance, which is being lead-managed by Wells Fargo Securities, is scheduled to price Wednesday, November 6, with indications of interest and price guidance on the Series 2019B and Series 2019 bonds slated for Tuesday, November 5.

In the meantime, other deals on the near-term horizon include almost US$780m worth of New Jersey Economic Development Authority school facility construction bonds, with nearly US$335m of that total in taxable notes; as well as around US$750m worth of general obligation bonds from the State of Illinois. 

Supply is likely to spike over the month of November, with the Bond Buyer’s U.S. 30-day visible supply signaling another US$20.3bn intraday Monday, according to Bloomberg.

Disclosure: Interactive Brokers

The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

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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