Week of 11/18/2019

High Yield Munis Bring Wins To High Yield Investors… Global Bond Buyers Hit By Negative Yields Flock To U.S. Municipal Bonds… Illinois Lawmakers Approve Pension Consolidation… Auto Labor Deal Credit Positive For Detroit… Fed Likely To Wait And Watch Data… Municipal Bond Prices Remain Attractive…

High Yield Munis Bring Wins To High Yield Investors…Goldman Sachs, Blackrock and other large institutional investors that piled investments into high yield muni bonds have outperformed investors who stayed on the sidelines. “No regrets,” says a Goldman Sachs Asset Management fund manager who has moved a record amount of investments to high yield muni bonds, adding “There are lots of opportunities for alpha generation in the muni market.” Goldman Sachs fund managers have favored buying state and local government debt that’s been “beat up” over the past few years such as Illinois bonds and New Jersey bonds. BlackRock increased its exposure to high yield muni bonds in recent months after underperforming relative to peers. Nuveen has been buying various Chicago debt and Puerto Rico Sales Tax bonds as some Puerto Rico bonds have rallied 17% this year even though the Island is still wading through bankruptcy. Some fund managers have pared down high yield muni bond holdings or stayed on the sidelines. A Thornburg portfolio manager told Bloomberg, “Everyone who isn’t running a high yield fund is losing to high yield, in the market we’re in, the longest dated and worst credits have been the most successful.” New junk rated deals continue to be aggressively sought by taxfree bond buyers. Progress in U.S.-China trade talks is making investors more comfortable with risks. With an outperforming index return of 9.6% this year amid steady inflows, high yield state and local government tax-free bonds are poised to beat their investment grade counterparts for a fourth straight year. GMS corporate traders expect over the next 12 months high yield taxable returns can be expected to be around 6% with investment grade taxable returns around 4%. Tax free high yield is currently around 4.50% (taxable equivalent in 37% tax bracket over 7.10%) with investment grade tax free around 3% (taxable equivalent in 37% tax bracket around 4.75%) over the next several years; consensus expects a low rate environment and a continued drawn out muted low growth U.S. recovery.

Global Bond Buyers Hit By Negative Yields Flock To U.S. Municipal Bonds…The unprecedented era of negative interest rates in Europe and Asia is turning some of America’s domestic securities into a valuable export. Even with interest rates holding near a more than half century low, the returns promised by the $3.8 trillion municipal bond market look good compared with the $13 trillion of negative yield sovereign debt that winds up costing investors to own. Foreign buyers have been a steadily growing presence in the U.S. Municipal market, doubling their direct holdings over the past decade to a record $102 billion by the end of June, according to Federal Reserve Board data. The interest has been given an added jolt in recent months because of a torrent of refinancing by states and cities, who have seen rates fall so much that they are selling taxable debt which carries higher yields to refinance tax-exempt securities. Overseas buyers are primarily interested in taxable bonds because they have no need for the U.S. income tax shelter typical municipal securities provide. U.S. Governments have sold about $48 billion of taxable bonds this year, a 119% increase from the same period 2018 and the most in almost a decade, according to data compiled by Bloomberg. Such debt has delivered a 10.5% return this year, according to the Bloomberg Barclays index. “This supply really helps to get focus and attract the broadest possible investor base,” said head of municipal capital markets at Citigroup Inc., which has a municipal bond banker stationed in London. “We’ve had quite a bit of interest from overseas for these issues.”

Illinois Lawmakers Approve Pension Consolidation…In a victory for Governor Pritzker, Illinois House and Senate approved Governor Pritzker’s bipartisan proposal to consolidate 650 local police and fire pension plans to ease funding pressures on Illinois local governments. The move could mean additional investment returns of up to $2.5 billion over the next five years and lower overhead costs. The measure raises pensionable salary cap, changes final salary calculation and reinstates surviving spouse benefits for police officers and fire fighters hired after Jan. 1, 2011. Pritzker said such costs will be far outweighed by administrative cost savings and increased investment returns. The win comes after previous attempts to consolidate pensions failed to gain traction as unions and political interests pushed to retain local control. Democratic Governor J.B. Pritzker called the bill’s passage “a vital step forward for our fiscal future” as it eases property tax burden on Illinois local governments. Governor Pritzker has created a taskforce to work on addressing state pensions and Chicago pensions, not included in the consolidation.

Auto Labor Deal Credit Positive For Detroit…A collective bargaining agreement with General Motors will keep a large auto factory open in Detroit. The deal preserves hundreds of jobs and supports Detroit’s rebounding income tax revenue. Resurgent income taxes has been key in Motor City’s robust financial performance. Besides the GM factory, Fiat Chrysler, Google Waymo and Ford Motor Company have committed to build auto plants in Detroit. Detroit is set to maintain or increase its share of the auto sector which is credit positive for Detroit.

Fed Likely To Wait And Watch Data…The Fed is likely to wait and see how the economy responds to three rate cuts. Recession fears have waned, although the two largest economies, U.S. and China, are expected to decelerate into 2020. Below 2% U.S. economic growth is expected in 2020. The Fed is optimistic that its three interest rate cuts this year would buoy the U.S. economy against lingering headwinds, Fed Chair Jerome Powell stated. Retail sales rose in October after falling in September. In contrast, U.S. industrial production fell in October, the third decline in four months. Price increases remain anemic with October Consumer Price Index up 1.8% from last year. The International Monetary Fund cut by more than half its forecast for the growth of world trade flows in 2019 to 1.1% from 2.5%. New York Fed President John Williams added, “Things can change. Data dependency remains our motto.”

Municipal Bond Prices Remain Attractive…Muni bond prices are attractive relative to taxable U.S. Treasury bonds. Tax-free muni bonds yield 96% of comparable U.S. Treasuries and on a taxable equivalent basis are more attractive than corporate bonds and company rated corporate bonds. The bond market awaits Port Authority of New York & New Jersey’s $1.1 billion bond issue and New York State Dormitory Authority bonds this week. Social Impact bonds for California’s ‘No Place Like Home’ $2 billion bond program will debut this week. Taxexempt in CA, the bonds will be repaid from a mental health tax levied on $1 million plus incomes and are rated a notch lower than CA general obligation bonds. Municipal bonds are experiencing record inflows as investors have added tax-free bonds for 45 straight weeks. New Jersey and Illinois bonds could feature in next month’s tax-free bond supply. Wall Street expects roughly $420-$440 billion muni bonds could be issued next year.

Compare 30-Year taxable U.S. Treasury yield 2.32% to 30-Year tax-exempt muni bond yield “AAA” 2.23%; “AA” 2.55%; “A” 2.64%; “BBB” 3.19%. For investors in the 35% tax-bracket, a 3.19% taxexempt yield is equivalent to a 4.9% taxable yield. Top rated tax-free bonds yield 96% of comparable taxable U.S. Treasuries.