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Recently, municipal bonds have performed well despite increased market volatility and a rising interest rate environment that saw the 10-year US Treasury yield breach 3% a number of times this year.1 The Bloomberg Barclays Investment Grade Municipal Bond Index has returned 0.49% and the corresponding high yield municipal index has returned 1.07%, quarter-to-date.2 We believe this strong muni performance was due in part to investor risk aversion that has benefitted both municipal bonds and Treasuries as well as a reduction in muni supply following the 2017 tax reform.
Tax reform created a rush to market in late 2017
The Tax Cuts and Jobs Act (TCJA) introduced in November 2017 created new concerns for municipal bond issuers. Uncertainty about the implementation of new policies resulted in a surge of new issuance at the end of 2017 that was originally scheduled for early 2018.
Among the concerns ahead of the TCJA’s final passage was it would eliminate private activity bonds (PABs), which help private companies, non-profit organizations and public authorities fund projects using tax-exempt municipal bonds. While this was not part of the final bill, uncertainty persisted until mid-December.
The law did, however, eliminate tax-exempt advance refunding bonds. These had allowed government issuers and non-profits to restructure eligible tax-exempt debt by refinancing at a lower rate or for a longer term. The uncertainty around PABs and the elimination of advance refunding bonds resulted in a spike of new issuance during December 2017 — $62.5 billion was issued that month alone. As a result, muni supply during the fourth quarter of 2017 was the highest it has been in the 32 years that the data have been recorded.3
Muni issuance down 20% through the first half of 2018
Since much of the supply that came in the later part of 2017 was originally slated for 2018, municipal issuance has been 20% lower so far this year compared to the same period last year.4 Total 2018 issuance is projected to reach around $330 billion, compared to $436 billion in 2017.4
On the demand side, although the TCJA lowered individual tax rates, individual tax relief has been limited. As a result, demand for municipals has remained solid.
Munis expected to remain strong through the end of the year
In addition to the strong supply/demand picture, Invesco Fixed Income believes that municipal bonds should continue to be supported by strong US macro and credit fundamentals. The US economy continues to grow above potential and we expect benign inflation for the remainder of 2018. On the heels of the economic expansion, general municipal credit fundamentals are also strong, in our view. New tax revenues from internet sales and legalized gambling should also support the finances of state and local governments.
As we look toward year-end, we are overweight single A- and triple-B-rated bonds, which we believe should perform well during periods of healthy economic growth. We may add exposure to higher yielding municipal bonds as well, mainly those with triple B- and double B-ratings. Our analysis suggests that spreads for these bonds should continue to tighten in reaction to decreased issuance. We prefer essential service revenue bonds as these issuers tend to avoid the pension liability risk associated with many general obligation bonds.
Interested in muni opportunities?
Investors interested in investing in municipal bonds may wish to consider:
Invesco Short Duration High Yield Municipal Fund: Because of its short duration, this fund may be less sensitive to changes in interest rates and may help reduce volatility in a fixed income portfolio.
Invesco Municipal Income Fund: While this fund’s credit quality is investment grade, we believe its yield makes it attractive on a risk versus reward basis.
1 Source: Bloomberg L.P., March 25, 2018, May 15, 2018 to May 23, 2018, Aug. 1, 2018.
2 Source: Bloomberg L.P., Aug. 21, 2018.
3 Source: Bond Buyer, Dec. 31, 2017.
4 Source: Bond Buyer, July 31, 2018.
Blog header image: Darren J Sabino/Shutterstock.com
The Bloomberg Barclays Global Aggregate Bond Index is an unmanaged index considered representative of the global investment-grade, fixed-rate bond market.
A municipal bond is typically a fixed income security issued on behalf of a local government authority.
A credit rating is an assessment provided by a nationally recognized statistical rating organization (NRSRO) of the creditworthiness of an issuer with respect to debt obligations, including specific securities, money market instruments or other debts.
Fixed income investments are subject to credit risk of the issuer and the effects of changing interest rates.
An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.
Junk (or non-investment grade) bonds involve a greater risk of default or price changes due to reduced issuer credit quality. The values of junk bonds fluctuate more than those of high quality bonds and can decline significantly over short time periods.
Senior Client Portfolio Manager1
Stephanie Larosiliere is the senior client portfolio manager for the Invesco Municipal Bond team. Ms. Larosiliere works with the fund management team, acting as its representative to retail clients and other intermediaries.
Her responsibilities include working with sales staff and clients to provide insight on the municipal fixed income market and the investment strategies utilized by the team. She is also responsible for ongoing product development and marketing for the municipal bond products.
Ms. Larosiliere joined Invesco in 2011 as a senior product manager supporting the municipal and convertible businesses. Prior to joining Invesco, Ms. Larosiliere served as a vice president in the Goldman Sachs Asset Management fixed income product management team where she was responsible for portfolio analysis, product development, client retention and marketing. Prior to joining Goldman Sachs in 2008, she worked as an institutional product management associate for Brown Brothers Harriman. She began her career in the industry in 2003 as a risk management analyst with JPMorgan Chase where she was responsible for performing daily value at risk (VaR) analysis and monthly stress risk tests on the bank’s credit portfolio.
Ms. Larosiliere earned a BBA degree in finance and investments from Baruch College — The City University of New York (CUNY).
1 Not involved in managing assets of any fund.