Muni Bond Supply Moves Higher, But Not How You Would Think

The 2019 rally in interest rates has triggered municipal investment bankers to dust off their refinancing calculators and pitch to their clients the financial benefits of taking out legacy high cost debt with new issuance at today’s lower interest rates.

Historically, this was a popular maneuver as municipalities were free to refinance outstanding tax-exempt bonds by issuing new bonds, also tax-free, at a lower interest rate. When the bonds being refinanced have a call or maturity date well into the future, this financial maneuver is known in the marketplace as an “advanced refunding” deal.

Historically, advanced refundings comprised a large portion of new municipal issuance. This activity ground to a halt in 2018, however, as a provision in the 2017 tax law change barred municipalities from bringing advanced refunding deals to the market, no longer granting the newly issued bonds tax-free status. As such, new municipal bond supply fell dramatically.

But yields have now dropped far enough to entice municipalities to re-engage in advanced refundings, with a twist—the twist being the newly issued bonds are fully taxable for investors. And even though the interest rate on a taxable bond is higher than that of a comparable tax-exempt bond, the math still works for municipalities to save money. Taxable municipal issuance is now on pace to reach levels not seen since 2010, when the popular Build America Bond program was in place.

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For us, increased taxable municipal supply is welcome news, as we have long allocated to the sector across our various strategies. We look at taxable municipals as corporate bond alternatives and have been pleased with the risk-adjusted returns of the sector versus corporates. Currently, we are seeing value across longer portions of the yield curve in taxable munis and are allocating across our various portfolio strategies accordingly. 

Source: Bloomberg, JP Morgan

Labor, Consumer Spending and the Economy

We all know that the U.S. economy is heavily reliant on consumer spending, and consumer spending is reliant on people being employed. So, to understand where the U.S. economy is going we need to have a view on employment. Pretty straight forward, so far….

However, there is a lot of mixed data to sift through, and everyone wants to be the first to anticipate market moves. Last week’s non-farm payroll report for August showed a lower than expected gain of 130,000, a number that supports the rationale for another Fed rate cut in September. The data print was consistent with the longer-term trend of slower growth in non-farm payrolls (see chart below). This trend is not encouraging. But in our opinion, when it comes to the health of the economy, it is more important to look at the unemployment rate, which is now at 50-year lows while still trending lower.

As we know, most of us will spend more when we are employed, which is good for the economy.

Chart 1: Nonfarm payroll yearly change and U.S, Unemployment

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The other bit of mixed news last week was the Manufacturing Purchasing Managers Index (PMI) coming in at 49.1%, indicating U.S. manufacturing is contracting, which of course is bad for employment. But this weak manufacturing data is balanced against an uptick in the arguably more important non-manufacturing index, now at 56.4%. If you put the two together you see a slowdown since the third quarter of last year, consistent with the slowdown in the pace of nonfarm payroll gains.

Looking forward we are cautious because most of the incremental data is negative, and we know the market can be volatile at this late stage in the business cycle. Still, our caution is tempered, as the slowdown in payrolls and manufacturing have not yet resulted in a higher unemployment rate.

At this point it is hard to bet unemployment rates will fall much further, and when the unemployment rate bottoms and starts to rise, spending will slow and the economy will cool. As we all know.

Sources: Bloomberg, The Financial Times

Jackson Hole Used to Be Sleepy

The Federal Reserve Bank of Kansas City’s Economic Policy Symposium in Jackson Hole, Wyoming, is one of the longest-standing central banking conferences in the world. The event brings together economists, financial market participants, academics, U.S. government representatives and news media to discuss long-term policy issues of mutual concern. It’s usually just a few days in the fresh air and a few good nights’ sleep.


But this year everyone was wide awake, sitting upright and listening intently, particularly to the Fed Chairman’s comments at the beginning of the conference last Friday. His comments can move markets, influence geopolitics and even prompt real time pointed responses from the U.S. President.

 Markets were hoping for confirmation the Fed would continue to support risky assets by aggressively cutting rates. Markets are understandably nervous given the recent evidence of slower global growth (especially in Europe and China), escalating trade wars, potential for a hard Brexit, and unrest in the Middle East.

 Mr. Powell gave no confirmation of aggressive rate cuts in the coming months, but the consensus is there will be another measured cut in September.

 In his speech, Mr. Powell offered a history lesson on Fed actions since 1950 and a sober rationale for the Fed’s belief the economy is in a favorable place, citing low unemployment and close to target inflation. Still, he acknowledged recent developments are “eventful,” the economy faces significant risks, and the Fed has few historical lessons on how to respond to trade wars. He did little to provide hope for aggressive rate cuts. His speech can be found at:

 His history lesson, though quite good, was upstaged by China’s announcement of tariff retaliation, and Washington’s promise of further retaliation for China’s actions. As the trade war escalated, risk markets sold off aggressively and safe haven assets rallied.

 But as we have said before, this volatility is welcome news to investors who have kept portfolios generally conservative. We will be on the lookout for opportunities to use our “dry-powder” when bonds we find attractive are offered at a discount.

 Sources: The Federal Reserve, Bloomberg, The Financial Times

The Week That Made Bond Investors Popular

It is rare that the U.S. Treasury market becomes a topic of conversation in everyday life. Yet here we are, where friends and family are asking us what is happening in our markets and what it means for the broad economy. In a sense, we as bond investors are starting to feel…popular?

The renewed interest in our work has been driven by the inversion of the 2yr / 10yr yield curve, where the yield on the 2-year Treasury is higher than the yield on the 10-year Treasury. This phenomenon has caught so much attention because of its rarity, and more importantly, its precedent of accurately predicting economic recessions. On that topic, our global strategy team put out a note last week discussing the inversion and how we should be thinking about it in the current economic and market environment (

As we determine how to position portfolios, we see certain strengths in the economy. From a top-down view we still believe the Fed is at least neutral (if not accommodating) after a decade of zero interest rates. Fiscal support (government deficits) are at extraordinary levels for a non-recessionary period, banks are lending, the capital markets are open, and unemployment is at a 50-year low.

However, the clouds on the horizon are building. The Fed may have raised rates too fast (a policy mistake), we are seeing negative economic impacts from trade wars, corporate profit growth has slowed, and geopolitical risks are high. Moving forward, we think that watching corporate behavior closely will be important in determining whether this inversion is a false signal or an actual precursor of a recession. As mentioned in the strategy piece we linked above, corporate America has begun to slow capital spending. Should C-Suites also decide to start trimming jobs, the consumer, which has powered through the recent market volatility, could come under pressure. Then all bets are off.

The investment grade bond market is behaving as expected given the recent bout of volatility. Treasuries and other high quality (AA and AAA rated) bonds are performing well, while bonds on the lower-end of the ratings spectrum have come under pressure. Municipal returns have lagged, which is typical when Treasuries have sharp moves, but we expect them to catch up. In all, now is not the time to try and hit home runs. We plan on continuing to collect our coupon payments and watch how this all plays out as we assess current and potential opportunities.

Source: Bloomberg, Invesco

Municipals Perform Well Despite Global Volatility

Bloomberg is reporting that through last week, the municipal market is having its best year since 2014. The combination of declining U.S. Treasury yields and a positive technical backdrop has driven returns between 3% and 7% year-to-date, depending on maturity. Importantly, munis are behaving as expected in what is proving to be a volatile market environment.


Municipal yields typically follow the direction of U.S. Treasury yields, with this year being no exception. U.S. Treasury yields have fallen between 75 and 100 basis points across the yield curve with municipals largely following suit.


One reason why munis are keeping up with the sharp rally in Treasuries is a highly supportive technical backdrop, where new issuance has been muted and demand is strong. On the issuance side, the elimination of refunding transactions that was included in the 2018 tax bill has dramatically reduced supply. In addition, flows into the municipal space have been robust. As measured by weekly mutual fund inflows, the market has experienced 31 straight weeks of inflows.


In a world where concerns are mounting over the global economy, the U.S. centric municipal market is performing well fundamentally. The unemployment rate is low, consumer spending is steady and property values remain elevated. These factors mean the various forms of tax receipts, which constitutes revenue for municipalities, are healthy. And while certain municipalities continue to face challenges from off balance sheet liabilities such as pension obligations, we are broadly seeing strength.

Portfolio Impacts:

We have responded to this performance in our crossover Blend Strategy by capturing strong municipal performance and moving into taxable bonds, including certain corporates. Particularly for short maturity bonds, investors can capture 2-3x the yields in investment grade corporate bonds versus investment grade municipals.

As we push through the remainder of 2019, we expect municipals will continue to perform well as many of the trends outlined above are expected to remain in place.

Source: Bloomberg