Since the presidential election, fixed income markets have been on a roller coaster. 10-year U.S. Treasury yields jumped from 1.80%, prior to the election, to 2.60% by the middle of December on concerns that President-elect Trump’s policies would inflate the economy. Diminished confidence in a quick passage of the President’s agenda caused markets to recalculate the possibility of pro-growth policies and yields dropped back to 2.20% by mid-April.
Immediately after the election, tax reform fears caused municipal bonds to underperform Treasuries. Most of the pain was felt in 10-year and longer bonds. Low supply and strong demand in the beginning of the year allowed municipals to outperform. April, historically a weak month for municipals, saw near-record mutual fund inflows, low new issuance and strong demand, focused mainly in the 2-7 year part of the yield curve. May saw a continuation of this trend.
Summer typically heralds a period of strong seasonal outperformance for municipal bonds caused by supply and demand imbalances.
Summer typically heralds a period of strong seasonal outperformance for municipal bonds caused by supply and demand imbalances. Usually, more bonds mature than are issued. This net negative issuance provides strong support to the municipal market. This year, the period of net negative issuance is projected to last into the fall providing further support to the municipal market. However, talk about tax reform or pro-growth policies could roil the municipal market.
The summer also brings the possibility of the Federal Reserve raising short term rates again. Currently, internal Federal Reserve projections are predicting two more rate increases in 2017 and three more in 2018. However, fixed income markets are only pricing in one additional hike this year and one more in 2018. Though still in early stages, we are monitoring the Federal Reserve’s discussions of a reduction of their balance sheet. As expectations evolve, markets will react accordingly.
This year, the period of net negative issuance is projected to last into the fall providing further support to the municipal market.
Credit quality in the municipal market remains strong with a few exceptions. Currently, Hartford, Illinois, New Jersey, Puerto Rico, and credits related to the default of a nuclear power plant builder are under pressure. Pensions and deteriorating infrastructure are still a concern. However, rating agencies have recently issued more credit upgrades than downgrades but we believe credit quality has plateaued.
Over the next few months, interest rates may be affected by the economy, FOMC actions, international intrigue and U.S. politics. Still, we see support for the municipal market due to limited supply from net negative issuance this summer and fall.
This communication contains the personal opinions, as of the date set forth herein, about the securities, investments and/or economic subjects discussed by Mr. Bittner. No part of Mr. Bittner’s compensation was, is or will be related to any specific views contained in these materials. This communication is intended for information purposes only and does not recommend or solicit the purchase or sale of specific securities or investment services. Readers should not infer or assume that any securities, sectors or markets described were or will be profitable or are appropriate to meet the objectives, situation or needs of a particular individual or family, as the implementation of any financial strategy should only be made after consultation with your attorney, tax advisor and investment advisor. All material presented is compiled from sources believed to be reliable, but accuracy or completeness cannot be guaranteed.
