Muni Supply: Shrinking Market

According to a Bloomberg article published last week, municipal bond issuance has declined 25% this year versus the same time-frame in 2013.  Expectations are for $280 billion total supply this year resulting in negative net supply, and a 4th straight year of declining total size in the market.  At the same time, inflows into municipal bond mutual funds have been moderately positive all year, with about $2.9 billion being added in the month of May according to RBC research.  These technical factors have combined to push municipal bond performance higher than other investment grade fixed income options thus far in 2014.  Municipal bonds have outperformed Treasury bonds by nearly 3% after adjusting for comparable duration and taxes.  While there is some speculation that a heavy election year, including 36 states with gubernatorial elections, is a driver of lower issuance, a recent research piece from RBC shows that there is no correlation between heavy election years and declines in new issue volume.  Supply last week increased to $7 billion from $5 billion, while this week’s issuance is expected to be around $9 billion and the forward calendar shows moderately increasing supply further out.  Seasonal patterns dictate increasing maturities (i.e. cash to be reinvested) this time of year so we expect the rising supply will be absorbed by the market in an orderly fashion.  Studies have shown that trillions of dollars will be needed to be replace aging infrastructure and should drive greater issuance in the years to come. However, tighter budgets in recent years, an aversion to borrowing and growing off-balance sheet liabilities are factors contributing to the falling supply in the market.  Clients of SNW AM have benefitted from the performance generated through the current supply demand imbalance, and should also look forward to rising issuance in years to come as it will generate opportunities for portfolio managers to capitalize on relative value opportunities.