Highlights
• Municipal bonds were able to weather a supply spike and speculation of a Federal Reserve (Fed) rate hike to notch a 14th month of positive performance.
• Particularly strong demand for long-duration assets and relatively light supply in this area should continue to support performance at the long end of the curve.
• The Puerto Rico market responded well to Washington’s selection of seven board members to oversee fiscal and economic recovery efforts in the commonwealth.
Market Overview
The municipal market posted its 14th straight month of positive performance in August, extending its record-long winning streak and outpacing U.S. Treasuries. Strong employment data and more hawkish rhetoric from Fed officials caused markets to price in a higher probability of a September rate hike. This sparked a general rise in fixed income yields (and drop in prices), though munis found support in strong demand given the less volatile nature of the asset class.
New supply of $39.1 billion represented the largest August issuance on record, up 21% from 2015 and 28% above the five-year average. The spike might be attributed to issuance being pulled forward ahead of the upcoming presidential election and potential Fed rate hike. It also appears to compensate for a historically light July, with August supply up a notable 50% from the prior month. Demand for the asset class remains both consistent and firm, with nearly $7 billion in August inflows bringing the year-to-date (YTD) total to $47.3 billion. This is an average of approximately $1.4 billion in inflows per week (up 575% year-over-year), with the majority of monies directed to long-term muni funds.
Making Headlines
Month-end brought some progress on Puerto Rico, as President Obama named the seven members of the commonwealth’s Oversight Board ahead of the Sept. 15 deadline. The board members bring diverse backgrounds, which is important given the complexity of Puerto Rico’s problems. None of the selections appear to be overtly anti-creditor, which provided some comfort to the market, particularly as relates to the potential treatment of general obligation (GO) bonds. GOs experienced a modest relief rally on the news. We note that the presence of a former bankruptcy judge and a Penn law professor may signal that the board will invoke bankruptcy provisions down the road.
As Illinois continues to operate without a full package of budgeted spending authorizations, Moody’s expressed concern that the state’s credit position would deteriorate further as liquidity pressures mount. Meanwhile, Chicago Public Schools is seeking to increase property taxes by $250 million to address unfunded pension liabilities. But the schools’ budget hinges on $215 million in state aid that is subject to Illinois’ ability to reform its pensions. Ultimately, the near-term effort will be overshadowed by the rising tax burden on city residents and its long-term impact on budgetary flexibility.