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U.S. Muni Market: Surprisingly Strong U.S. Economy Sparks Fixed-Income Sell-Off


Senior Market Analyst at Interactive Brokers

Texas Set to Add to Taxable Supply

Investors have generally witnessed a recent rise in the yields of municipal bonds, as prices of U.S. government notes have fallen amid a rosier risk-taking backdrop. 

Market participants widely attribute the better risk tone in large part to a recent cooling in the U.S.-China trade battle, as well as an upbeat October employment report.

Nuveen analysts Bill Martin and John Miller noted that fixed income yields in general rose in the past week, but the sell-off was “orderly.” 

They added that markets continue to “adjust to the fact that the economy is not as weak as was feared over the summer,” while progress in the U.S.-China trade talks “made investors even more confident in the U.S. economy.”

Indeed, the upbeat mood in the financial markets remained intact Tuesday, after U.S. President Donald Trump made clear in a speech at the Economic Club of New York that it is the U.S. that is deciding whether it wants to strike a trade agreement with China. “We’re close,” to a partial deal, he said. “A significant phase-one trade deal with China could happen … could happen soon.”

The yield on the 10-year U.S. Treasury note was last bid at around 1.93%, an increase of 46 basis points since its recent trough of 1.47% set at the start of September. The spread between the 2-year and 10-year notes has also gapped wider by more than 25bps after having inverted briefly in late August.  

Against this backdrop, yields on longer-dated tax-exempt issuance ended last week higher by about 15bps, amid a bear steepened yield curve.

Analysts at Janney Montgomery observed that the1.62%, 10-year benchmark yield reached its highest level since early July, and the spread between the 2-year and 10-year yield has widened by more than 20bps to 45bps in the past month.

Janney added that most of last week’s new sales have traded at “cheaper levels” compared to  their original pricing, including the 30-year maturity of New Jersey Economic Development Authority’s (NJEDA) school facilities construction bonds, with blocks of the deal’s 4% trading at 3.78% yield-to-call, 5bps less expensive than its initial offering and 150bps over the ‘AAA’ benchmark yield.

Ongoing Strong Demand Undeterred

Demand for municipal bonds also remains ripe.

For the week ended November 6, Thomson Reuters/Lipper U.S. Fund Flows posted net inflows into muni bond funds (for the 44th straight week) of around US$951m, about on par with the prior week’s US$922m, and down only slightly from their weekly average of US$1.12bn since August 7, 2019.

Also, while 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 slipping, those losses have offset gains of 9.83% and 8.01%, respectively, from their most recent 52-week lows set in mid-November 2018 to their highs of mid-August.

Other recently priced deals include around US$750m worth of general obligation (GO) bonds from the State of Illinois, which priced at yields between 1.34% and 3.48%; as well as about US$745m worth of revenue bonds from the Colorado Health Facilities Authority, which sold at yields of between 1.2% to 3.8%.

Texas Set to Sell Taxable Supply

Meanwhile, fresh supply is set to continue to grace the new issue calendar, with a total of around US$12bn eyed for the week ahead, after last week’s volume rose by roughly US$2bn over the prior week to tally about US$11bn.

Strategists at Barclays noted that there has been a ramp-up of taxable supply recently, which has totaled around US$45bn in 2019, well above the US$30bn average since 2011 – following the expiry of the Build America Bond (BABs) program in 2010 – and nearly double the amount that was issued last year.

Barclays pointed out that one of the “main sources of the increased taxable supply has been the advance refunding of tax-exempts via taxable munis.” They said that while they think “this trend may continue,” some deals have already been affected given the current sell-off in fixed-income.

Barclays continued that although taxable spreads have “widened marginally, the weakness has been orderly and in general, the additional taxable supply we have seen over the last several weeks has been absorbed quite well thus far.”

“However, we note that recently this was likely due to low corporate issuance due to earnings blackouts, which was definitely a positive for the primary taxable muni market.”

Among the deals to price in the week ahead, the Texas Transportation Commission is on tap to sell a little over US$789.5m worth of ‘AAA’-rated, taxable highway improvement refunding bonds, Series 2019.

These general obligation bonds of Texas, which comprise serial and term bond maturities ranging from April 1, 2021 through April 1, 2044, are secured by the full faith and credit of the state.

The issuer said it will use net proceeds from the sale to advance refund a portion of the callable State of Texas Highway Improvement General Obligation (HIGO) bonds, Series 2012A and Series 2014.

The deal, which has been rated pristine triple-‘A’ credit ratings from each of the major ratings agencies — Moody’s Investors Service, S&P Global and Fitch Ratings — is being jointly lead-managed by RBC Capital Markets and J.P. Morgan.

Moody’s analyst Nicholas Samuels said the agency’s ‘Aaa’ GO rating reflects “multiple strengths, including a strong economy that will continue to outpace the nation, robust population growth, reserves that provide a healthy cushion even after recent appropriations, good fiscal management and governance, and low bonded debt, offset by high pension liabilities.”

He added that the outlook on the issuance is ‘stable,’ given the state’s “strong” economic fundamentals and reserve, however “balancing the budget competes with the demand for education, transportation and pension funding in the fast-growing state.”

Moody’s further highlighted that Texas is the second largest state by population and has the second largest state gross domestic product. Per capita personal income is 98% of the U.S. level, and it has the eleventh highest poverty rate among the states.

Indications of interest (IOIs) on the transaction are slated for Wednesday, while price guidance and coupon setting are expected to take place Thursday.

In the meantime, other deals on the near-term radar include close to US$1bn worth of tax-backed revenue bonds from the District of Columbia, including US$60m of taxable notes; as well as US$738m of San Diego County Regional Airport Authority subordinate revenue and revenue refunding bonds; and almost US$682.5bn of State of California GOs.

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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