The municipal bond market has entered 2018 rather quietly, compared to the fevered pitch it reached as we ushered out 2017. The start of the New Year has not been kind to those looking to put their money to work in the tax-free municipal bond market. An avalanche of new issue supply at the end of 2017, has all but dried up most new issue supply in early 2018. Demand for municipal bonds is still high as evidenced by the $110 million dollars into the iShares National Muni Bond ETF (NYSE:MUB) in the first week of 2018.
Investors can easily track muni bond yields and prices by watching one of the handful of municipal bond ETFs like: (NYSE:MUB) iShares National Muni Bond ETF. (NYSEARCA:BAB) PowerShares Taxable Municipal Bond ETF (BAB).
Wild Ride for Muni Bonds
Late 2017 threw the municipal market into one of its crazier rides of the recent past.
As 2017 came to a close, issuers were rapidly reacting to pending potential tax reform implications. Municipal bonds were one of the targets of the tax reform legislation that passed the House and Senate, to be eventually signed into law by President Donald Trump. Legislators undoubtedly felt pressure to find ways to plug the ten year, $1.7 trillion dollar budgetary gap that lowering of corporate and individual tax rates might bring about according the Congressional Budget Office (CBO). Municipal bonds fared much better than other areas of the tax code, namely SALT (State and Local Tax) and mortgage interest deductions. The new tax reform was still monumental for the $3.7 trillion dollar municipal market. Legislators had threatened initially to repeal all private activity bonds (PABs), but backed off that proposal when they quickly realized that such a radical change to the landscape would jeopardize infrastructure finance. PABs have, for over a century, been the financial tool used to finance the construction of universities, airports, hospitals and other projects that service the public good. Congress (not a well-liked group) did however, eliminate an issuer’s ability to advance refund outstanding bonds. Municipal bond issuers from states, cities, hospitals, and sewer authorities use advance refunding bonds when interest rates fall, to pay off prior debt and reduce their interest expense, akin to refinancing one’s home mortgage.
Issuers became eager to tap the municipal market while they still had access to tools they had become accustomed to, PABs and advanced refunding’s. Bond issuers rushed to market with a deluge of supply in the waning days of 2017 to beat the clock. So much so that new issue supply in December 2017 hit an all-time high of $55.6 billion, up almost 200% from same month, the year prior. The unusually large supply saturated the market causing prices to fall and yields to rise.
From Flood to Drought Conditions
Within the first week of 2018, investors shook off the water from the muni supply drenching only to find themselves parched and crawling through the market looking for yield. The supply was all gone and the muni market was again arid – starved for yield.
So far in January 2018 we have tracked just $6.5 billion in new deals. Now, halfway through January, we can comfortably assume that the total January issuance will fall far short from December 2017 record breaking number – possibly down by more than 85%.
Under normal market conditions January typically sees light supply, with a large number of interest payments hitting accounts and fresh first of the year investable bond cash that wants to be put to work. January’s new issue muni bond vacuum has only made this year worse as issuers have gone very quiet.
Rising US Treasury Yields Remain a Threat
2018 has not been a quiet year for the treasury market either. Rates have popped on the short end of the yield curve. In the summer of 2017 rates on the 2 year treasury were below 1.30% and we have seen a significant move on the short end over the last 9 months. The rate on a 2 year treasury has moved from a 1.92% to start 2018 to a 2.06% as of 01/19/2017. This pop in rates on the short end, coupled with a more modest move upward in rates on the long end has contributed to the flattening of the yield curve. The yield curve flattens when short term rates and long term rates converge towards each other. The lack of new issue supply in the municipal market has allowed prices on muni bonds to remain stable and in some cases rise as treasury prices fall. While these discrepancies should even out over time, for now, anemic supply has cushioned munis from an otherwise considerable move in US Treasury rates.
With interesting new deals coming to market in January such as Chicago’s second go-around with their new sales tax securitization structure and as we see more preliminary official statements hitting the wire, 2018 should certainly pick up steam. 2018 will not be without some sparks, but nothing like the fireworks that we saw at the end of 2017.
Disclosure: NatAlliance Securities LLC may hold a position in all bonds referenced, and in the future may be a buyer or a seller of the securities. This is not a recommendation to buy, sell, or hold the securities. Las Olas Wealth Management is a wealth management group within NatAlliance Securities LLC.: I, Dean Myerow, wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock or bond is mentioned in this article.
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