Sector Views – Municipal Bonds: Climate Report

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This Municipal Bonds sector report is excerpted from the Fourth Quarter 2018 Fastened-Earnings Outlook

Favorable technical dynamics and optimistic headlines buoyed municipal bond efficiency in 2018. Whereas complete issuance declined by 20 p.c yr over yr, new cash provide elevated by 22 p.c over the identical interval and has been persistently met with extra demand. In the meantime, the AAA-rated tax-exempt municipal yield curve skilled a extra parallel shift increased versus the bear flattener seen in Treasurys, offering better relative compensation for assuming length danger.

AAA Tax-Exempt Munis Supplied Higher Danger Compensation than Treasurys

The AAA-rated tax-exempt municipal yield curve skilled a extra parallel shift increased versus the bear flattener seen in Treasurys, offering better relative compensation for assuming length.

Since 2017, traditionally tight spreads have mirrored enhancing credit score developments, highlighted by well timed state budgets, Supreme Court docket selections with favorable fiscal implications (e.g., South Dakota v. Wayfair, Janus v. AFSCME), and Puerto Rico’s consensual restructuring negotiations. Nevertheless, we consider these favorable elements are greater than offset by states’ mounting fiscal challenges forward of the subsequent recession, which we consider will start within the first half of 2020. We anticipate municipalities to be much less ready to climate the subsequent financial downturn given the smaller relative measurement of their reserves in comparison with previous cycles, and inflexible budgets hampered by rising healthcare and pension prices.

Most States' Reserves Have Declined Because the Final Downturn

Change in State Fund Balances as % of Expenditures Since 2007
Favorable elements are greater than offset by many state issuers’ mounting fiscal challenges as we method recession within the first half of 2020. We anticipate municipalities to be much less ready to climate the subsequent financial downturn given the smaller relative measurement of their reserves in comparison with previous cycles.

Structural pension points will solely compound within the financial downturn as pension belongings are instantly susceptible to fairness market efficiency. Our Macroeconomic and Funding Analysis Group's work signifies that U.S. shares might see peak-to-trough declines of greater than 40 p.c within the subsequent bear market, which might additional undermine municipal issuers' credit score high quality by increasing pension funding gaps—or in different phrases leverage.

Over the previous yr, the municipal market has been amenable to issuers' undesirable late-cycle habits resembling changing bond paperwork with weaker provisions, using aggressive financing methods (e.g., use of pension obligation bonds), and issuing tax securitizations with zero-sum implications for basic obligation bondholders. As we proceed to look at diminished market liquidity, we stay targeted on the necessity for credit score self-discipline and defensive positioning.

—James Cross, Senior Managing Director; Allen Li, CFA, Managing Director; Michael Park, Vice President

Vital Notices and Disclosures

This text is distributed for informational functions solely and shouldn't be thought-about as investing recommendation or a suggestion of any specific safety, technique or funding product. It incorporates opinions of the authors however not essentially these of Guggenheim Companions or its subsidiaries. The authors’ opinions are topic to alter with out discover. Data contained herein has been obtained from sources believed to be dependable, however should not assured as to accuracy. Previous efficiency isn't any assure of future outcomes.

Investing entails danger. Normally, the worth of fixed-income securities fall when rates of interest rise. Excessive-yield securities current extra liquidity and credit score danger than funding grade bonds and could also be topic to better volatility. Asset-backed securities, together with mortgage-backed securities, might have buildings that make their response to rates of interest and different elements troublesome to foretell, making their costs risky and they're topic to liquidity danger. Investments in floating fee senior secured syndicated financial institution loans and different floating fee securities contain particular forms of dangers, together with credit score danger, rate of interest danger, liquidity danger and prepayment danger. Guggenheim Investments represents the next affiliated funding administration companies of Guggenheim Companions, LLC: Guggenheim Companions Funding Administration, LLC, Safety Traders, LLC, Guggenheim Funds Funding Advisors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Actual Property, LLC, GS GAMMA Advisors, LLC, Guggenheim Companions Europe Restricted, and Guggenheim Companions India Administration. ©2018, Guggenheim Companions, LLC. No a part of this text could also be reproduced in any kind, or referred to in every other publication, with out categorical written permission of Guggenheim Companions, LLC.