Strong technical conditions combined with lower interest rates drove municipal returns in 2019. As we look forward to 2020, we see positive returns from the asset class but to a lesser degree than experienced this past year. With rates expected to stay low and trade in a range, we expect low, single-digit returns from the municipal asset class with income being the primary driver of return.
The municipal market experienced record flows into tax-exempt bond funds during 2019, in part fueled by the realization of higher effective tax rates resulting from the SALT provision in the Tax Cuts and Jobs Act. Investors also had a record amount of money returned to them in the form of calls, principal payments, and coupon interest. This was against a backdrop of supply being below the five-year average for tax-exempt new issuance. These two trends continue as it’s expected that 2020 will be another year in which a significant amount of capital is returned to investors, and tax new money issuance is expected to be lower by approximately 5-10% than the approximately $350 billion sold in 2019.
Rates will ultimately play the key role in how large the new-issue calendar is in 2020. If rates are lower than anticipated, we could see more refunding deals come which would send the calendar north of the approximately $425 billion expected. One trend that exerted itself and will likely continue in 2020 will be the advanced refunding of tax-exempt issues with taxable issues. This unexpectedly added to aggregate new-issue supply in 2019 and will be a substantial portion of supply in 2020. This phenomenon ultimately reduces the amount of outstanding tax-exempt debt.
In sum, strong technicals remain in the municipal market, rates are range bound, and we anticipate the asset class produces low, single-digit returns for 2020.