On several occasions we have touched on the topic of low-to-negative sovereign yields around the globe as a driver of demand for Treasuries, and as a major factor pushing down U.S. yields. We have also mentioned more than once that muni demand, as measured by net inflows in to municipal bond funds, has been quite strong for the last few quarters. In May, we even mentioned the confluence of these two factors, which has driven increased foreign demand into the municipal space despite the multitude of hurdles (no tax exemption benefit, more idiosyncratic credit risks than U.S. Treasury or Agency debt, wider bid/ask spreads and of course currency hedging risk). The result of tumbling rates in the U.S., combined with surging demand in the municipal space specifically, has been an ongoing tightening in municipal credit spreads. Generic A and BBB rating category spreads are now sitting at their lowest levels since before the financial crisis. This spread tightening has seemed to snowball as investor’s creeped out across the credit spectrum to attain greater yields. As can be seen in the chart below, there has been a recent tightening in BBB rated municipal debt as gross yield levels for the AAA benchmark scale set new all-time lows, passing prior record lows set in 2012. We are still able to maintain our spread targets on select issues and sectors, but have taken an approach favoring higher-grade credits, all else being equal.
Source: Bloomberg, Citi Research, Reuters