Strategy Municipal Bond Market Weekly Bottom Line: The U.S. Treasury yields rose sharply on a hawkishly-perceived interpretation of the FOMC meeting statement. Municipal yields hung on and the 10-yr AAA GO Ratio fell precipitously. Muni fund flows saw net inflows Chicago passed property tax hike to be used for pension contributions Chapter 9 bankruptcies at multi-year lows Municipal bond sector relative YTD performance won by tobacco settlement revenue bonds (+11.4%) with state GOs with the lowest relative performance (+1.6%). Puerto Rico: o S&P Puerto Rico Total Return Index was +0.2% last week; -6.5% YTD. What Happened in the Bond Markets Last Week? Last week Treasurys were flat until the FOMC meeting conclusion on Wednesday. The resulting statement caused the market to perceive a higher likelihood of a hastened pace of Fed Rate hikes. Over the next three days yields never looked back as they continued rising. Even mixed-to-weak economic data did little hold yields back. In essence, the FOMC did not downgrade growth expectations, faded their previous concern over global market developments, acknowledged slowing of labor improvements and spoke more concretely about the possibility of raising the Fed Funds rate in December. The market implied probability of such a hike moved from approximately 35% to 50% currently. Municipal yields certainly did not participate in the flight away from safety as muni yields were little changed. The resulting 10-yr AAA GO Ratio fell markedly to 96.6 from 102.0 just prior to the FOMC meeting and is now near the lowest level since early July. Yields (Figure 1) For the week ending 10/30/15 Treasury yields traded higher; 2-year Treasury Note yields +8.3 bps to 0.73%, 5- year Notes yields were +10.2 bps to 1.52%, 10-year Notes yields were +5.5 bps to 2.14% and 30-year bonds yields were +2.2 bps to 2.92%. Bloomberg Municipal Index curve yields were lower: AAA-rated GO yields; 2-year bonds were -1 bps at 0.52%, 5-year bond yields were -2 bps to 1.22%, 10-year bond yields were -3 bps at 2.07% and 30-year bonds were +1 bps at 3.15%. The Ratio of 10-year AAA GO debt to 10-year Treasury yields finished at 101.2 on Friday up slightly from the previous Friday s ratio of 100.1. The year-to-date average is 102.6 and the 12-month average is 100.1. David N. Violette, CFA Sr. Fixed Income Analyst Vice President dviolette@rwbaird.com 414-298-7688 1 o
Figure 1 - Yield Curve and Muni Curve Changes Data Source: Bloomberg One can observe these changes by looking at how rates have changed along the curve for both the Treasury curve and for the AAA-rated G.O. Index since last week. The top panel shows four yield curves; two for the Treasury curve (in red) - one for the most current date and one from last week and two for the AAA-rated G.O. (in blue) - current and last week. The bottom panel of the graph shows changes in the rates along both curves for the week for both Treasuries and the AAA G.O. Index. 2 o
110.0 Figure 2 - Muni Ratio Data Source: Bloomberg AAA 10-Year G.O. Muni Ratio to Treasury 105.0 Ratio (%) 100.0 95.0 90.0 96.6 85.0 Mid Price SMAVG (50) Bond Buyer Indexes (Table 1 and Figure 3): Last week, Bond Buyer Indices were all little changed with the Bond Buyer 20-GO Index yield -1 bps to 3.66% and Bond Buyer 25-Revenue Index unchanged at 4.05%. Table 1 - Bond Buyer Indexes Source: Bloomberg Index Yield % Yield Last Week 1 Week Change (bps) Yield 1 Month Ago 1 Month Change (bps) Bond Buyer 20 Gen'l Obligation Index 3.66 3.67-1.0 3.71-5.0 Bond Buyer 11 Gen'l Obligation Index 3.18 3.18 0.0 3.23-5.0 Bond Buyer 25 Revenue Index 4.05 4.05 0.0 4.1-5.0 Yield (%) 4.8 4.6 4.4 4.2 4 3.8 3.6 3.4 3.2 Figure 3- Bond Buyer Indexes - 1 Year; Data Source: Bloomberg Bond Buyer Indexes 1 year Bond Buyer 25 Revenue Bond Buyer 20 General Obligation 3 o
What Are Market Participants Talking/Writing About? Supply (Figure 4) Bloomberg 30-Day Supply currently stands at $11.1B, up from last week s $7.5B. The YTD average is $10.7B and the 12 mos. average is $10.6B. In October 2015, refundings declined 38.3% (data from Bond Buyer) from October last year, and total issuance was down from October 2014. This follows from Sept. 2015 issuance being lower than September 2014. Bloomberg 30-Day Visible Supply U.S. Total 25,000 20,000 $ Million 15,000 10,000 5,000 0 Articles of Interest Municipal Fund Flows: According to Lipper FMI, municipal bond funds reported net inflows of $349 million after $241 million during the previous week. Net inflows have occurred in 23 of 44 weeks in 2015. The four-week moving average net inflow is $456 million. High-yield funds also had net inflows last week. Chicago City Council Passes Budget: Chicago s city council approved a property tax hike last week. The property tax hike ($543 million over the next four years, including $318 million in 2015) will be used for pension contribution funding. The pension plans are only 35.5% funded. Moody s calls this a positive step. Chicago has budgeted $978 million in 2016 for pension contributions but still falls short of the actuarially-required contribution of $1.7 billion. Municipal Sector Performance (Bloomberg Brief): According to a Bloomberg Brief article summarizing S&P Dow Jones municipal YTD sector performance (through Q3) shows the tobacco revenue bond sector to have vastly outperformed all others with State G.O.s registering the lowest relative returns. (see graphic on following page) 4 o
Chapter 9 Bankruptcies (Bloomberg Brief): According to a Bloomberg Brief article, municipal Chapter 9 bankruptcies have totaled three year-to-date in 2015, down from nine last year. The 30-yr average is 8 per-year. See Graph below. Puerto Rico: o The S&P Municipal Bond Puerto Rico Index finished at 159.4 on Friday vs. 159.0 at the end of the previous week, +0.2%. Year-to-date the index is -6.5%. 5 o
S&P Municipal Bond Puerto Rico Index Level (1-year) Relative Value by Maturity Table 2 - AAA Muni Ratios and Spreads by Maturity - Data Source: Bloomberg 11/2/2015 Yield-to-Maturity (%) 0% Tax Rate 35% Tax Equivalent Maturity (yrs.) AAA Gen. Oblig. Treasury Spread (bps) Ratio (%) Spread (bps) Ratio (%) 1 0.27 0.33-6.6 80.0 7.7 123.1 2 0.52 0.74-22.3 70.1 5.8 107.8 3 0.79 1.05-26.5 74.7 15.7 115.0 4 1.00 1.38-38.0 72.5 16.0 111.6 5 1.22 1.55-32.8 78.9 33.0 121.3 7 1.61 1.91-30.1 84.2 56.7 129.6 10 2.07 2.17-9.8 95.5 101.8 146.9 15 2.43 2.43 0.3 100.1 131.1 154.0 20 2.76 2.61 15.1 105.8 163.7 162.8 25 2.99 2.78 21.3 107.7 182.3 165.6 30 3.15 2.95 20.7 107.0 190.5 164.7 6 o
Figure 5 AAA General Obligation Ratios and Spreads Data Source: Bloomberg Ratio % 115.00 105.00 95.00 85.00 75.00 65.00 55.00 AAA G.O. Muni Ratio and Spreads (0% Tax Convention) 1 3 5 10 20 30 Maturity (yrs.) 30.0 20.0 10.0 0.0-10.0-20.0-30.0-40.0-50.0 Spread (bps) Ratio (%) (Left) Spread (bps) Right Relative Value by Rating Figure 6 Muni Index Yield Curve by Credit Rating Data Source: Bloomberg 4.50 4.00 Muni Yields by Rating 3.50 3.00 Yield (%) 2.50 2.00 1.50 1.00 0.50 0.00 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 Treasury AAA AA A 7 o
Figure 7 Muni Index Ratios by Maturity and by Credit Rating Data Source: Bloomberg 165 Muni Ratios by Rating 145 Ratio (%) 125 105 85 65 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 AAA AA A Figure 8 Muni Index Spread to Treasuries by Maturity and by Credit Rating Data Source: Bloomberg Spread (bps) 140.00 120.00 100.00 80.00 60.00 40.00 20.00 0.00-20.00-40.00-60.00 Muni Spread (bps) by Rating 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 AAA AA A Relative Value by State General Obligation Table 3 State G.O. Yields, Spreads, Ratios, Changes and Credit Ratings Data Source: Bloomberg Data Unavailable For more information please contact your Financial Advisor. 8 o
Appendix Important Disclosures Some of the potential risks associated with fixed income investments include call risk, reinvestment risk, default risk and inflation risk. Additionally, it is important that an investor is familiar with the inverse relationship between a bond s price and its yield. Bond prices will fall as interest rates rise and vice versa. When considering a potential investment, investors should compare the credit qualities of available bond issues before they invest. The two most recognized rating agencies that assign credit ratings to bond issuers are Moody's Investors Service ( Moody s ) and Standard & Poor's Corporation ( S&P ). Moody s lowest investment-grade rating for a bond is Baa3 and S&P s lowest investment-grade rating for a bond is BBB-. The Bond Buyer 20-Bond Index consists of 20 general obligation bonds that mature in 20 years. The average rating of the 20 bonds is roughly equivalent to Moody's Investors Service's Aa2 rating and Standard & Poor's Corp.'s AA. The Bond Buyer 11-Bond Index uses a select group of 11 bonds in the 20-Bond Index. The average rating of the 11 bonds is roughly equivalent to Moody's Aa1 and S&P's AA-plus. The Bond Buyer Revenue Bond Index consists of 25 various revenue bonds that mature in 30 years. The average rating is roughly equivalent to Moody's A1 and S&P's A-plus. The indexes represent theoretical yields rather than actual price or yield quotations. Municipal bond traders are asked to estimate what a current-coupon bond for each issuer in the indexes would yield if the bond was sold at par value. The indexes are simple averages of the average estimated yields of the bonds, are unmanaged and a direct investment cannot be made in them. This is not a complete analysis of every material fact regarding any sector, municipality or security. The opinions expressed here reflect our judgment at this date and are subject to change. The information has been obtained from sources we consider to be reliable, but we cannot guarantee the accuracy. Municipal securities investments are not appropriate for all investors, especially those taxed at lower rates. The alternative minimum tax (AMT) may be applicable, even for securities identified as tax-exempt. It is strongly recommended that an investor discuss with their financial professional all materially important information such as risks, ratings and tax implications prior to making an investment. Past performance is not a guarantee of future results. This report does not provide recipients with information or advice that is sufficient on which to base an investment decision. This report does not take into account the specific investment objectives, financial situation, or need of any particular client and may not be suitable for all types of investors. Recipients should consider the contents of this report as a single factor in making an investment decision. Additional fundamental and other analyses would be required to make an investment decision about any individual security identified in this report. ADDITIONAL INFORMATION ON SECURITIES MENTIONED HEREIN IS AVAILABLE UPON REQUEST BY CONTACTING YOUR BAIRD INVESTMENT PROFESSIONAL. Copyright 2015 Robert W. Baird & Co. Incorporated. 9 o