In the 2Q 2019 issue of our quarterly publication, we:
- Assess the supply–demand imbalance in the municipal bond market and provide an overview of performance.
- Explore the credit stability of Illinois in the wake of the budget passage and remaining long-term challenges.
- Focus on other post-employment benefit liabilities—a growing municipal credit challenge.
Second-quarter performance for municipals remained strong, due to quarter-end talk of Federal Reserve interest rate cuts and the supply and demand imbalance—which continued to keep credit spreads and absolute yields low. The S&P Municipal Bond Index returned 2.12% for the quarter and 4.94% year to date. Fund flows as reported by Lipper Inc. were $43.8 billion through June 30, which is the largest amount of inflows for the time period since the data series began in 1992.
The strong inflow demand combined with muted supply has continued to keep ratios, credit spreads, and absolute yields low. The strong demand continued to be influenced by the Tax Cuts and Jobs Act (TCJA) of 2017, which limited the amount of state and local taxes that can be deducted from federal taxes (the SALT deduction). A result of tax reform is an increase in investor appetite for more tax-free income—especially in high-tax states, such as New York, California, Connecticut, and New Jersey. Yields available in municipal bonds in those states in particular are significantly lower (prices are higher) than comparable yields available in other similarly rated state and local issuers. At the same time, municipals were one of the best-performing asset classes last year so investors may be shifting more to municipals in anticipation of a retraction in the 10-year bull equity market.
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