The municipal market, as measured by the Bloomberg Barclays Municipal Bond Index, gained .31 basis points in the fourth quarter. The strong technical condition turned less positive during the quarter as the market priced approximately $143 billion in supply up 54% year over year. The municipal high yield market, as measured by the Bloomberg Barclays High Yield Index, gained .30 basis points.
This positive performance was against a backdrop of rising Treasury rates in the 5-30-year part of the curve, as rates rose 12 basis points in 5 years and 26 basis points in 30 years. Rates rose as clarity around a Phase 1 trade deal with China, Brexit, improvement in some of the economic data series, and the Federal Reserve leaving rates unchanged at their final meeting in 2019, suggesting the fed funds rate was appropriate to support sustained expansion of the economy and meeting their longer-term objectives.
The municipal market also saw rates rise in the 10 to 30-year part of the curve, with rates rising anywhere from 2 to 8 basis points, outperforming Treasury rates during the quarter. This led to municipal ratios gaining during the quarter with 5, 10, and 30-year ratios tightening approximately 12, 10, and 13 ratios respectively.
Municipal credit saw BBB outperform, once again, gaining 1.03%, with AAA gaining .72 and both AA and single A gaining .71 basis points.
2019 was a strong year for the asset class. The Bloomberg Barclays Municipal Bond Index gained 7.54% and the Bloomberg Barclays High Yield Index gained 10.68%. These are absolute numbers not tax adjusted. 2019 was the first-time investors experienced the impact of higher effective tax rates resulting from the Tax Cuts and Jobs Act. Given the backdrop of declining rates amidst tame inflation, the municipal market experienced record inflows, the key catalyst to the municipal performance in 2019. The key question is where does that leave municipal investors in 2020?
As we stated in our outlook video, we believe US Treasury rates are likely to be range bound. Given the fact it’s an election year, the likelihood of any significant policy initiatives being passed in Congress is low. The most recent release of the Fed minutes indicates the desire for policy makers to keep rates low in the hope of sustaining economic activity.
The municipal market will likely see supply increase from the approximate $420 billion aggregate number priced in 2019 but in our view, the key for municipal investors is the composition of supply. The upside in 2019 and the largest variable in 2020 will be taxable municipal issuance. Tax-exempt advanced refundings, prohibited under the TCJA, are economically feasible with taxable debt. Taxable issuance was approximately $70 billion in 2019 up substantially from the long run's $30 billion average.* The amount of taxable debt expected in 2020 is approximately $90 billion but could be well over $100 billion. Quite simply, taxable refunding issuance takes away tax-exempt supply. These refunding issues would historically have been replaced with a tax-exempt refunding deal. The amount of tax-exempt debt is not expected to rise in 2020. This will keep investors looking for the most efficient way to access tax-exempt income, which we believe is through mutual funds.
With 2020 starting the year with rates lower and spreads tighter than the start of 2019, we do not expect the magnitude of returns experienced in 2019. We look for low to mid-single-digit returns driven by the income component of total return. 2020 will be a year that will challenge investors to select the right credits and successfully navigate what could likely be a volatile environment.
Happy New Year! Good luck and thank you for listening.