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Municipal Podcast recorded on April 10, 2018

March 2018 Market Recap

Podcast Transcript

Hello this is Natalie Baker, vice president of marketing at Breckinridge and welcome to the Breckinridge podcast. Today we will be talking about market events, particularly for municipals, for the month of March. I'm joined by Eric Haase, a member of our portfolio management team, and he'll be recounting some of the major market events for the month. So Eric, last month Sarah discussed the increase in volatility seen in the markets. Did this continue into the month of March?

It did continue. So, equity markets remained on edge primarily due to rising trade tensions with China, increased scrutiny of technology companies and other factors as well. There was an increase in tariffs including steel and aluminum by the U.S. That resulted in the declaration of offsetting tariffs by China, and then on the technology front, concerns regarding data privacy, potential regulation, and high valuations have weighed on the sector.

Okay in addition to the tariff headlines, I know the FOMC has been a source of volatility over recent months. As expected, at Powell's first meeting he raised the Fed funds rate. Did we learn anything else from the statement or Fed minutes?

So you're right, the FOMC did raise the Fed funds rate to a target range of 1.5% to 1.75% at the March meeting. What they did was they kept the dot plot for 2018 consistent. That means the expectation of two more rate increases in 2018, so a total of three for the year. But based on economic data there's still a chance that this number could be pushed to four rate hikes.

Were there any changes to the pace of tightening based on the dot plot expectations looking further out in the future?

There were. So, 2018 was left unchanged but they increased the pace of hikes for both 2019 and 2020. This reflects an increase in median projections for longer maturity rates and the terminal rate, but I would point out that the terminal rate does remain below 3%.

Okay, so when can we expect the next FOMC rate increase?

Right now, the market is a 63% probability of a hike in June and potentially another in September.

Okay, and one thing that is influencing rate hike expectations is, of course, economic data. Can you speak a little bit about the economic data that we saw during March?

Sure. So growth remains reasonable. Q4 GDP came in at 2.9%. Additionally, inflation continues to remain in check, so Core CPI registered in at 1.8% for February, while Core PCE was up 1.6%. And again, these are both below the Fed’s target of 2%. On the consumer side, consumer confidence took a slight dip to 127.7 from 130, but keep in mind that confidence is still at a high that we had not seen since 2000.

Okay, and how does the employment picture look?

Employment remains strong. February’s non-farm payroll number was revised up to 326,000. For context, the trialing three-year average has been 199,000, and the unemployment rate remains at 4.1% which is steady, and where we have been for the past two quarters.

How did the Treasury markets react over the course of the month?

Well it changed from what we have seen on a year-to-date basis. The U.S. Treasury curve flattened over the course of the month. The two-year ended the month higher by 2 basis points, so at a 2.27% yield, while the ten-year ended at a 2.74%, lower by 12 basis points. The 30-year ended lower at 2.97%, which was a change of 15 basis points.

Was the flattening that we saw in March enough to offset the steepening that we saw earlier in the quarter?

Unfortunately, it was not. Through Q1 the two-year yield was higher by 38 basis points while the ten-year remains 33 basis points higher than when we started the year. The five and 30-year maturities ended higher by 35 basis points and 25 basis points, respectively.

Okay. And switching gears now to talk about munis. Did municipals continue to outperform U.S. Treasuries in March?

So, municipals underperformed U.S. Treasuries during the month of March particularly in the short end of the curve. The two-year muni to Treasury ratio increased from 67% to 73% while the five-year increased by about five ratios to end at 80%. The 10 and 30-year ratios ended at 88% and 99% respectively, higher by around two ratios or less.

So on a year-to-date basis, how have munis performed relative to Treasuries?

For the first quarter, municipal bonds on the short end of the curve outperformed the most. The two-year ratio went from 83% down to 73%, however most of the curve did under-perform with the five and 10-year maturity closing the month at 80% and 89%. The 30-year ratio ended at 99%.

And how were market technicals in March?

March issuance jumped to $25 billion which was a 47% increase from last month and a 24% drop from March 2017. On the demand side, mutual funds posted four consecutive weeks of inflows in March with $37 million posted for the week ending March 28th. That pushed the four-week moving average to $307 million.

How does this compare to first-quarter numbers?

So year-to-date supply totaled $63 billion which is still a 32% decline from the same period last year. On a year-to-date basis, municipal market has seen aggregate fund flows of $6.5 billion through Q1.

And with reduced primary issuance how much are you doing in the secondary market?

So, historically we've done closer to 50% of our purchasing in the secondary market but with lower supply, we have seen a dramatic uptick in that number. Now we are doing greater than 70% on average in the secondary.

Okay, and last month, Sarah mentioned that banks were selling which has been increasing secondary trading. Have you seen any interesting metrics to help explain this?

Yes, so it is true that in 2018 there has been an increase in dealer inventories and the amount of bonds for sale on bid wanted lists. The daily average dealer inventory for bonds with maturities greater than 10 years was around $11 billion in 2017, while that number has jumped to approximately $14 billion in 2018. Additionally, the daily average par amount of municipal bonds on bid wanted lists has increased from $640 million a day in 2017 to $855 million in 2018.

Okay, so let us talk about performance. Performance has been negative on a year-to-date basis through February. Did March provide positive returns?

So, despite under-performing U.S. Treasuries, municipals did reverse course from February and posted positive returns for March. So, the Bloomberg Barclays Municipal Bond Index closed the month up 37 basis points but still down -1.1% for the year. The Bloomberg Barclays 1 to 10-year blend posted a positive 9 basis points for the month and a -71 basis points for the year. As the curve flattened, longer dated maturities outperformed over the course of the month.

What were the best performing sectors and how did credit perform?

So, hospitals were one better sectors of the month and they returned 55 basis points, followed by education and water/sewer sectors. Lower quality bonds outperformed with BBB and A outpacing higher-rated credits by between 10 and 20 basis points.

Were there any changes to your credit outlook?

Municipal credit conditions remain largely unchanged from February. Many states are reporting an uptick in tax collections which mostly represent one-time revenues according to officials. The impact of the state local tax provisions remain unclear for most municipal market participants. Additionally, passage of the federal budget for fiscal year 2018 includes a substantial boost for defense spending and the lifting of sequester caps for non-defense items like R&D. This should boost economic activity in some regions and perhaps benefit research oriented higher education and hospital credits. And have you seen any changes in the headline credit stories? On the willingness front, Connecticut announced it will assume Hartford's $550 million in general obligation debt. This development should reduce near-term borrowing costs for certain local general obligations in the state. However, over time Connecticut may be less capable of resolving local budgetary problems in this matter.

Okay, thanks, Eric. We hope that you in the field have found this informative and we look forward to you joining us on our next podcast. Thank you.




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