Municipal market review: Income in focus
July 31, 2019
After a strong first quarter, the markets faced uncertainty around trade and global growth in the second quarter of 2019. Listen as Jake van Roden, head of municipal trading, portfolio manager , reviews market drivers, performance, and the current backdrop for what’s expected moving into the second half of 2019.
The municipal market posted a return of approximately 2% for the second quarter of 2019, while the market continues to see record inflows into tax-exempt bond funds. Year-to-date returns on the municipal bond index are roughly 5% for the first half of 2019. Lipper reported inflows of roughly $21 billion for the quarter, leaving us up approximately $44 billion year to date.
Municipal supply, on the other hand, was down 11% versus the second quarter of 2018 and is flat year to date versus the first two quarters of 2018, according to the Bond Buyer. Coupled with the record flows into tax exempt bond funds, the market performed extremely well on the strong technical.
With this backdrop, municipals outperformed Treasurys in the early part of the second quarter, hitting a historic low of 71% in 10-year ratios in early May. However, as Treasurys rallied into the end of May, municipals lagged and ended the quarter at roughly 79% in 10 years.
Uncertainty around trade and global growth resulted in a more accommodative tone from both the European Central Bank as well as the Federal Reserve. As a result, the World Interest Rate Probability (WIRP) of a September 2019 rate cut increased from 46% at the start of the quarter to 99% by the end of the quarter. The accommodative positioning by the Fed resulted in falling short-term rates and a steeper curve for both Treasurys and municipals for the month of June.
From a performance perspective, the long end of the curve outperformed the front end with 2s to 30s flattening five basis points, and lower quality outperformed higher quality, a scenario that favored both long and high yield strategies. In the later part of first quarter, Puerto Rico Sales Tax backed-bonds, known as COFINA, re-entered the high yield index after its debt was restructured. The new bonds were a major contributor to the high yield index, representing about 7% and generating just shy of a 4% return on the quarter.
Through the remainder of 2019, we expect the market to see relatively muted trading ranges for rates, and therefore, believe income will be the key driver of return in the second half of the year.
Thanks for listening and good luck investing in the second half of 2019.
Unless otherwise indicated, the sources of the data are Bloomberg, Bloomberg Barclays Indices, the Federal Reserve, and Lipper.
For institutional investor, investment professional use only – not for use with the public.
Investing involves risk, including the possible loss of principal.
Past performance does not guarantee future results.
The Bloomberg Barclays High-Yield Municipal Bond Index measures the total return performance of the long-term, non-investment-grade tax-exempt bond market.
The Bloomberg Barclays Municipal Bond Index measures the total return performance of the long-term, investment grade tax-exempt bond market.
Bloomberg's World Interest Rate Probability (WIRP) function estimates the probability of various ranges for the three-month average federal funds rate.
Fixed income securities and bond funds can lose value, and investors can lose principal, as interest rates rise. They also may be affected by economic conditions that hinder an issuer’s ability to make interest and principal payments on its debt.
Fixed income investments may also be subject to prepayment risk, the risk that the principal of a bond that is held by a portfolio will be prepaid prior to maturity, at the time when interest rates are lower than what the bond was paying. A portfolio may then have to reinvest that money at a lower interest rate.
Ex-US investors may not benefit from potential tax advantages associated with investing in US municipal bonds.
High yielding, non-investment-grade bonds (junk bonds) involve higher risk than investment grade bonds.
Index performance returns do not reflect any management fees, transaction costs or expenses. Indices are unmanaged and one cannot invest directly in an index.
Substantially all dividend income derived from tax-free funds is exempt from federal income tax. Some income may be subject to state or local and/or the federal alternative minimum tax (AMT) that applies to certain investors. Capital gains, if any, are taxable.
The views expressed represent the Investment team’s assessment of the market environment as of July 2019 and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice.
Other than Macquarie Bank Limited (MBL), none of the entities noted in this presentation are authorised deposit taking institutions for the purposes of the Banking Act 1959 (Commonwealth of Australia). The obligations of these entities do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of these entities, unless noted otherwise.
Macquarie Investment Management (MIM) is the marketing name for the following investment advisers: Macquarie Investment Management Business Trust, Macquarie Funds Management Hong Kong Limited, Macquarie Investment Management Austria Kapitalanlage AG, Macquarie Investment Management Global Limited, Macquarie Investment Management Europe Limited, Macquarie Capital Investment Management LLC, and Macquarie Investment Management Europe S.A.
For recipients in the United States, this document is provided by Macquarie Investment Management Business Trust (MIMBT). Institutional investment management is provided by Macquarie Investment Management Advisers (MIMA), a series of MIMBT. MIMBT is a US registered investment advisor, and may not be able to provide investment advisory services to certain clients in certain jurisdictions.