Municipal Supply Surges on Tax Reform Proposals

Since the beginning of November, tax reform details have been released, reviewed and absorbed by market participants. There are still steps to be completed before any reforms are finalized since, at the time of writing (late Friday afternoon), the Senate has not passed their bill and it has material differences from the House bill. However, because the proposed reforms involve provisions that would limit certain types of municipal bond issuance starting January 1 of 2018, there has been a rush to get deals done before the end of the year. 

Visible supply, which is useful as a directional indicator of issuance trends, has exploded in the last two weeks, surpassing the levels reached during October 2016 & 2010. Both months previously held post-crisis records of monthly issuance. In anticipation of this deluge of supply, the municipal market has been building in a concession. Muni yields rose for 9 straight trading sessions prior to November 30th. AAA rates rose 48 bps in the 2-year tenor, 37 bps in 5 years and 20 bps in 10 years since November 1st versus a Treasury rate increase of +17 bps in 2 years, +12 bps 5 in years and +4 bps in 10 years. Municipal to Treasury ratios have increased 21 points, 15 points and 8 points for the same tenors and time frame. In part, this move is related to short municipal rates catching up to the move in TSYs that has been driven by the looming Fed hike later this month, but the primary driver is the anticipation of increased supply. 

As the market has cheapened up, the opportunity to buy bonds has become attractive. We expect that ratios will fall as we move through the first quarter of 2018, since supply is expected to be lower and much of the current calendar increase is merely cannibalizing deals from 2018.

Source: Barclays, Bloomberg