Muni Supply Still Elevated, Demand Keeping Pace

As we began 2015, our expectation was for a heavy year of municipal bond issuance driven by refunding deals (municipal refinancing) given how low rates had fallen during the course of 2014 and through January of this year.  During the first half of the year, despite a modest increase in rates (particularly longer-term rates), our expectations were met with $212 billion issued through the end of the second quarter versus $139 billion for the same period last year.  A driving factor in last year’s strong performance for municipals was tight supply and an imbalance against strong demand.  The heavy issuance during the first half of the year contributed to the underperformance of municipal bonds versus taxable bonds, with the BAML 1-10 year muni index returning 0.239% through 6/30/15 versus the BAML AAA-A corporate & government 1-10 year index returning 0.876% for the same period.  The pace of municipal bond issuance was expected to decline through the summer, which is a traditional seasonal pattern, while cash to reinvest from maturities and called bonds, as well as from coupon payments, was expected to accelerate materially.  June through August are seasonally heavy maturity and coupon payment months for municipalities, as these months coincide with their fiscal years. We expected this to cause net supply to turn negative for the first time in 2015.  However, over the last 2 weeks, we have seen issuance accelerate to a slightly higher pace than the level of weekly supply we have already seen year-to-date, with roughly $10 billion issued in both of the last two weeks.  Despite the substantial issuance, municipal bonds have seen strong demand. The heavy new issue calendar has been well received and municipal bond performance is outpacing taxable bonds QTD, 0.498% versus 0.08%.  Supply is still expected to slow over the next couple of months before another likely uptick in the second half of the fourth quarter.  This relative outperformance has benefited our Blend strategy, where we made a shift into greater municipal exposure during June.

Sources: Bloomberg & BAML Indices