A Powerful First Quarter Rally – Will It Continue?

The tax-exempt market exhibited a powerful rally during the first quarter of 2014. Technicals were exceptionally strong during January and February, as heavy reinvestment flows of coupons/calls/maturities coincided with a very anemic new issuance cycle.  Municipal 10-year yields during these months collapsed by 37 basis points (bps), which was almost in line with the 38 bps drop in 10-year treasuries. However, performance in March was mixed.  The fixed income markets began accounting for an anticipation of earlier-than-expected tightening in monetary policy.  This pricing was driven by recent comments from Federal Reserve Chairman Janet Yellen.  The results were a flattening of the municipal yield curve, with 5-year yields rising by 31 bps, while 30-year yields fell by 7 bps.

Supply technicals should continue to be generally favorable for municipals.  Year-to-date supply of $62.5 billion is running well below 2013’s issuance by 26%.  The primary catalyst for the downward trend remains muted refinancing opportunities for municipalities.  After the second half of 2013 experienced refinancing declines of 48% versus the same period in 2012, the downtrend has continued in 2014 with declines of 52% versus the first three months of 2013.  With interest rates expected to gradually move higher over the course of the year, this trend is expected to remain in place.

In looking forward over the next quarter, demand should continue to improve.  After the market moves past potential cash-flow needs leading into the April 15 tax-filing deadline, demand flows should see gradual improvement as we move into the stronger technicals that develop around the summer months.  Net supply is expected to decline to a total of -$25 billion during July and August.  Additionally, net supply during April, May and June is expected to reach a total of only +$6 billion, which is expected to be very manageable for the quarter.  As of this writing, municipal 10-year tax-adjusted yield spread levels to Treasuries stand at 91 bps, which still remains modestly attractive, especially when compared to current 10-year taxable municipal spreads of 67 bps.  With a manageable new issuance cycle ahead for the market, we expect municipals to remain in a tight trading range around current levels, before a tightening bias develops as the market moves into stronger technicals starting in late June.

Gregory A. Bell, CFA, CPA
Director of Municipal Bonds

Disclaimer: Asset Allocation & Management Company, LLC (AAM) is an investment adviser registered with the Securities and Exchange Commission, specializing in fixed-income asset management services for insurance companies. This information was developed using publicly available information, internally developed data and outside sources believed to be reliable. While all reasonable care has been taken to ensure that the facts stated and the opinions given are accurate, complete and reasonable, liability is expressly disclaimed by AAM and any affiliates (collectively known as “AAM”), and their representative officers and employees. This report has been prepared for informational purposes only and does not purport to represent a complete analysis of any security, company or industry discussed. Any opinions and/or recommendations expressed are subject to change without notice and should be considered only as part of a diversified portfolio. A complete list of investment recommendations made during the past year is available upon request. Past performance is not an indication of future returns.

This information is distributed to recipients including AAM, any of which may have acted on the basis of the information, or may have an ownership interest in securities to which the information relates. It may also be distributed to clients of AAM, as well as to other recipients with whom no such client relationship exists. Providing this information does not, in and of itself, constitute a recommendation by AAM, nor does it imply that the purchase or sale of any security is suitable for the recipient. Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, inflation, liquidity, valuation, volatility, prepayment and extension. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.

 

Disclaimer: Asset Allocation & Management Company, LLC (AAM) is an investment adviser registered with the Securities and Exchange Commission, specializing in fixed-income asset management services for insurance companies. Registration does not imply a certain level of skill or training. This information was developed using publicly available information, internally developed data and outside sources believed to be reliable. While all reasonable care has been taken to ensure that the facts stated and the opinions given are accurate, complete and reasonable, liability is expressly disclaimed by AAM and any affiliates (collectively known as “AAM”), and their representative officers and employees. This report has been prepared for informational purposes only and does not purport to represent a complete analysis of any security, company or industry discussed. Any opinions and/or recommendations expressed are subject to change without notice and should be considered only as part of a diversified portfolio. Any opinions and statements contained herein of financial market trends based on market conditions constitute our judgment. This material may contain projections or other forward-looking statements regarding future events, targets or expectations, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved, and may be significantly different than that discussed here. The information presented, including any statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Although the assumptions underlying the forward-looking statements that may be contained herein are believed to be reasonable they can be affected by inaccurate assumptions or by known or unknown risks and uncertainties. AAM assumes no duty to provide updates to any analysis contained herein. A complete list of investment recommendations made during the past year is available upon request. Past performance is not an indication of future returns. This information is distributed to recipients including AAM, any of which may have acted on the basis of the information, or may have an ownership interest in securities to which the information relates. It may also be distributed to clients of AAM, as well as to other recipients with whom no such client relationship exists. Providing this information does not, in and of itself, constitute a recommendation by AAM, nor does it imply that the purchase or sale of any security is suitable for the recipient. Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, inflation, liquidity, valuation, volatility, prepayment and extension. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.