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Perspective published on January 3, 2019

Five Key Themes in the Municipal Market

1. TCJA Still a Key Factor

  • The Tax Cuts and Jobs Act (TCJA) continues to play a major role in municipal bond performance. For instance, lower corporate tax rates have made tax-exempt debt less attractive to banks and P&C insurers.
  • Weaker demand from banks and the shift in composition of the buyer base will continue to impact the shape and relative value along the municipal curve. However, rising ratios1 could eventually be capped, as higher yields could entice yield-conscious investors to purchase long-end debt or retail investors to extend duration.
  • On the flip side, the TCJA capped the state and local tax deduction, making tax-exempt debt more attractive to residents of high-tax states like California (see Pricing and the Way Forward in California Muni Bonds). This demand trend could spill over to other high-tax states such as Maryland and New Jersey, as residents of those states are likely to receive higher tax bills in 2019.

2. Increased Prospects for an Infrastructure Bill

  • With the election of a split Congress in November, the now-Democratic House of Representatives could work with President Donald Trump to push infrastructure legislation (see Quick Post-Election Thoughts on Munis). If passed, overall supply might increase relative to expectations.
  • State credit quality is generally solid, with state revenues up 7 percent for 3Q18. One positive impact of the TCJA is that it spurred growth and helped boost income and sales tax revenues. Overall, state and local tax revenue rose 7 percent year-over-year in 3Q18 (Figure 1).
  • In the absence of a federal plan, steadily improving state and local tax revenues could help fund infrastructure  (see Is It Morning Again in America for Infrastructure?). We expect new money issuance (for infrastructure), along with the overall low level of rates (for current refundings), to drive issuance in 2019.

3. Oil and Real Estate Prices in Focus

  • Oil prices dropped 33 percent in 2018.3 The impact of low oil prices is mixed. If prices stay low, it is likely to be a credit negative for oil and gas states such as Louisiana, Oklahoma and New Mexico. However, lower oil prices could be a credit positive for other issuers. Lower oil prices can lead to higher disposable income and may buoy consumption. Lower oil prices could also benefit local governments. They spend money on gas for motor vehicle fleets and purchase oil-correlated inputs such as asphalt for infrastructure projects.
  • The residential real estate market showed signs of softening in Q4 2018. Slower real estate price appreciation, or outright price declines in some markets, could trim local property tax receipts. Softening in real estate pricing is generally credit negative, although property taxes are collected on a 2-3 year lag, relative to prices, in most jurisdictions.

4. Outflows, but Outperformance Versus Most Other Fixed Income Sectors

  • Municipal total returns outpaced those of most other fixed income sectors in 2018 despite municipal fund outflows of $1.3 billion over the year.4 The Bloomberg Barclays Municipal Index posted positive total returns, while equities, investment grade corporates and high yield corporates had negative performance. Municipal total returns were higher than those of Treasury, Government-Related and Securitized indices for the year.5
  • Notably, tax-exempt money market mutual funds reported inflows of $1.3 billion for the week ending December 26, bringing 2018 inflows to more than $15 billion. Tax-exempt money market inflows reflected the risk-off sentiment in markets and the aversion to duration from retail investors.
  • Money market funds have also benefited from the multiple Fed rate hikes in 2018, and their yields are now a more-compelling alternative to stocks or longer-duration assets after years of hovering near zero. This could continue due to the Fed’s path toward rate normalization (see Assessing Duration in Rising Rate Environments).

5. Treasury Issuance to Ramp Up

  • In 2019, Treasury issuance is likely to increase due to the rising U.S. deficit. New spending priorities in Congress, including a fix for the Affordable Care Act, coupled with growing entitlement needs and pressure on defense spending, imply higher Treasury supply.
  • At the same time, the Fed’s portfolio runoff means that reinvestments will slow, and investors will need to digest more Treasury supply. The supply and demand imbalance in the Treasury market could pressure Treasury yields higher relative to municipals, causing municipal ratios to fall.


[1] Ratios refer to municipal yields as a percentage of Treasury yields.

[2] U.S. Census, Quarterly Summary of State and Local Government Tax Revenue: 2018 Q3, released December 18, 2018.

[3] Bloomberg, as of December 31, 2018. WTI oil price.

[4] Lipper, as of December 26, 2018. Based on weekly reporting funds.

[5] Bloomberg Barclays Municipal Bond Index, Bloomberg Barclays High Yield Index, and Bloomberg Barclays Aggregate Index, Major Components.

DISCLAIMER: The opinions and views expressed are those of Breckinridge Capital Advisors, Inc. They are current as of the date(s) indicated but are subject to change without notice. Any estimates, targets, and projections are based on Breckinridge research, analysis and assumptions. No assurances can be made that any such estimate, target or projection will be accurate; actual results may differ substantially.

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