Municipal Market Update Municipal bond yields spike after falling near two-year lows

Dorian Jamison, Municipal Analyst
Municipal
Market Update
A timely look at trends and
developments for muni bond
investors
October 22, 2014
Municipal bond yields spike after falling near two-year lows
Following concerns over a global economic slowdown, municipal market indices showed that municipal
yields fell near two-year lows in mid-October. Since then, municipal yields have spiked and municipal bonds
have underperformed Treasuries, leaving munis relatively more attractive.
Yield curve
From September 30 to October 15 the Municipal
Market Data (MMD) “AAA” 10-year benchmark
yield fell 36 basis points to 1.81 percent, a 17-month
low and just 34 basis points above its all-time low. In
less than one-week, the 10-year benchmark yield has
risen 21 basis points to 2.02 percent as of October 21.
From September 30 to October 15 the MMD “AAA”
30-year benchmark yield fell 34 basis points to 2.75
percent, a 21-month low and just 28 basis points
above its all-time low. Since then, the 30-year
benchmark yield has risen 20 basis points to 2.95
percent as of October 21 (See Figure 1).
Spreads to AAA
Thom son MMD Curve
1-Day
1-Week 1-Month
3.9%
2.9%
(9.3%)
(0.0%)
(0.0%) (11.1%)
(0.0%)
(0.0%)
(0.0%)
(0.0%)
0.0%
(0.0%)
5 Year
AAA Yield
AA
A
BBB
Current
1.07
8 bps
31 bps
84 bps
10 Year
AAA Yield
AA
A
BBB
Current
2.02
21 bps
58 bps
106 bps
1-Day
4.1%
5.0%
5.5%
0.0%
1-Week
6.3%
10.5%
7.4%
1.0%
30 Year
AAA Yield
AA
A
BBB
Current
2.95
22 bps
60 bps
96 bps
1-Day
2.1%
0.0%
7.1%
0.0%
1-Week
4.2%
10.0%
11.1%
2.1%
3-Month
(13.7%)
(33.3%)
(26.2%)
(16.0%)
1-Year
(17.7%)
(33.3%)
(39.2%)
(28.2%)
1-Month
(10.6%)
10.5%
3.6%
(2.8%)
3-Month
(9.4%)
0.0%
(6.5%)
(11.7%)
1-Year
(22.9%)
(16.0%)
(29.3%)
(30.3%)
1-Month
(7.2%)
10.0%
7.1%
1.1%
3-Month
(10.3%)
0.0%
(10.4%)
(14.3%)
1-Year
(30.1%)
(15.4%)
(18.9%)
(24.4%)
Source: Thomson Municipal Market Monitor (TM3)
Past performance is not an indication of future results.
The municipal yield curve has flattened
significantly over the course of the year, particularly
on the long-end of the yield curve. For example, the
slope between the 15- and 30-year maturities was 52
basis points on September 8, which is a 5-year low
and indicates that investors have continued to reach
for yield, driving bond prices up and yields down on
the long-end of the yield curve. Since then the slope
has steepened modestly to 59 basis points, as of
October 21.
Since municipal bond buyers can pick up 80 percent
of the high grade municipal yield curve within 15
years, it is not necessary for investors to take on
additional interest rate risk by venturing out too far
on the yield curve. In fact, it is currently possible to
pick up more than two-thirds of the Municipal
Market Data (MMD) triple-A yield curve within 10
years and more than half of the yield curve within
seven years due to the relative steepness of the
intermediate portion of the municipal yield curve
(See Figure 2).
Credit spread tightening
The municipal bond market has returned 8.4 percent
year-to-date, according to the S&P National AMTFree Municipal Bond Index. Municipal bond
outperformance has seen municipal yields decline
close to two-year lows, which has led many investors
to move down the credit scale in search of yield.
This search for yield has caused the difference
Please see pages 7-8 of this report for Important Disclosures, Disclaimers and
Analyst Certification
Page 1 of 8
Municipal Market Update
between yields on lower quality bonds and high
quality bonds to narrow (i.e. credit spread
tightening). Credit spread refers to the difference in
yield between two issues that are identical in all
respects other than their credit quality. Advisory
Services Group (ASG) Municipal Research
continues to point out that strategy preference for
lower rated bonds is not without risk in a still
challenging credit environment, since lower rated
credits might experience weak performance should
spreads widen back to their recent averages.
For example, the outperformance of 10-year triple-B
rated municipal bonds relative to high grade
municipal bonds has left the credit spread between
10-year triple-B and high grade municipal bonds 66
basis points tighter than the five-year average
spread of 171 basis points and 34 basis points tighter
than the 10-year average spread of 139 basis points .
Since peaking at a 12-month high of 156 basis points
on January 2, the credit spread between 10-year
triple-B rated municipal bonds and triple-A
municipal bonds has tightened to 105 basis points
on October 17, a six-year low (See Figure 3). The
current spread relationship suggests that
intermediate-term triple-B bonds are currently fully
valued relative to high quality municipal bonds,
which suggests that investors may not be
compensated for the added credit risk that triple-B
bonds can present.
Municipal Spread Monitor
The Municipal Spread Monitor table (MSM) on
page 6 shows the weekly change in the spread
relationship between the yield to maturity of
representative holdings of Wells Fargo Advisors’
clients’ municipal bonds and the Bloomberg “AAA”
municipal benchmark. Bond prices and yields have
an inverse relationship. Widening yield spreads are
highlighted in red to indicate cheapening in bond
prices relative to the municipal benchmark.
Tightening yield spreads are highlighted in green to
indicate bond prices that are getting richer relative
to the municipal benchmark. Standard deviations
highlighted in red are greater than or equal to two
standard deviations above the average, suggesting
the bonds are undervalued relative to the “AAA”
municipal benchmark. Standard deviations
October 22, 2014
highlighted in yellow are between one and two
standard deviations away from the average, and
suggest that the bonds are fully valued relative to
the municipal benchmark.
Supply
Municipalities have borrowed $227.7 billion in debt
in 7,768 issues through the end of September,
compared to $253.4 billion in 8,924 issues through
September 2013—representing a 10 percent decrease
year-over-year—according to data tracked by
Thomson Reuters. This decrease in municipal
supply has continued to support municipal bond
valuations. As of October 21, the municipal bond
market was up 8.4 percent year-to-date after
declining 3.2 percent in 2013, as measured by the
S&P National AMT-Free Municipal Bond Index.
However year-over-year supply has increased in
three out of the last four months.
Weekly tax-exempt supply has averaged $5.7 billion
during October, which is more than the year-to-date
weekly average of $5.3 billion. Municipal supply has
increased during the month of October in eight
consecutive years. The Bloomberg 30-day visible
municipal supply was $10.3 billion on October 1,
which is above the 12-month average of $7.2 billion.
On average, this seasonal supply increase has
coincided with the market remaining flat to
declining modestly during October, as measured by
the S&P National AMT-Free Municipal Bond Index.
Month-to-date the municipal market is up 0.8
percent, as of October 21.
Demand
Demand as measured by flows into municipal bond
funds has remained strong, which has enabled the
market to accommodate the supply increase over
the last several months. Last week, U.S. municipal
bond funds posted a 14th consecutive week of
inflows and the 23rd inflow in the past 24 weeks. As
reported on October 15, net inflows were $443.9
million compared to $762.2 million of inflows the
previous week, a five-month high. According to
Lipper FMI—after ending 2013 with 31 consecutive
weeks of outflows—municipal bond funds have
experienced net inflows 35 out of 42 weeks year-todate, totaling more than $8.9 billion.
Page 2 of 8
Municipal Market Update
October 22, 2014
Relative value
month average. The MMD 30-year triple-A muni-toTreasury yield ratio still remains below its 10-year
average of 102 percent, which suggests that munis
remain expensive relative to Treasuries compared to
the 10-year average ratio (See Figure 4).
Muni-to-Treasury yield ratios—a measurement of
relative value—suggest that municipal bonds have
underperformed Treasuries recently, leaving munis
cheaper relative to Treasuries. The MMD 10-year
triple-A muni-to-Treasury yield ratio has risen from
84.7 percent on October 16—a five-month low—to
90.9 percent on October 21, near a three-month high.
However, the MMD 10-year triple-A muni-toTreasury yield ratio still remains slightly below its
10-year average of 92 percent. The MMD 30-year
triple-A muni-to-Treasury yield ratio has risen from
94.9 percent on October 16—near a 16-month low—to
98.6 percent on October 21, which is above the three-
Period
Date
2 Year
5 Year
10 Year
30 Year
Even though municipal bond outperformance in
2014 has caused muni-to-Treasury yield ratios to
decline below long-term averages, tax-exempt
municipal bonds can be attractive to taxable
investors given that upper tier tax rates rose in 2013,
which has resulted in lower after-tax investment
yields on fixed income products that are not tax
advantaged.
MMD Municipal-Treasury Ratio
Current 1 Week 1 Month 3 Month 6 Month 1 Year 5 Year
Avg
+1 StDev -1 StDev
10/21/14 10/14/14 9/23/14
7/22/14
4/22/14 10/22/13 10/27/09 12/31/93
90.7%
90.9%
63.3%
65.4%
86.4% 119.9% 75.3%
84.8%
110.6%
59.0%
74.9%
72.0%
66.5%
75.0%
67.4% 95.2%
79.2%
81.7%
96.1%
67.3%
90.9%
86.5%
87.4%
90.5%
84.3% 102.3% 88.5%
86.7%
97.8%
75.6%
98.6%
95.9%
96.5%
101.1%
100.6% 116.0% 96.6%
95.7%
108.3%
83.0%
Source: Thomson Municipal Market Monitor (TM3), October 21, 2014
Past performance is not an indication of future results.
Figure 1: 30YR MMD “AAA” GO YIELD (Oct. 21, 2011 – Oct. 21, 2014)
4.51%
@ 9/5/13
(Three-Year High)
3.71%
@ 6/23/11
3.39%
(Two-Year Average Line)
2.47%
@ 11/28/12
(All-time Low)
2.95%
@
10/21/14
2.75%
@ 10/15/14
(21-Month Low)
Source: Thomson Municipal Market Monitor (TM3)
Page 3 of 8
Municipal Market Update
October 22, 2014
Figure 2: MMD “AAA” General Obligation Yield Curve (Oct. 21, 2013 – Oct. 21, 2014)
10-yr
(-59 bps)
62% to 68%
of yield curve
7-yr
(-37 bps)
46% to 54%
of yield
curve
2-yr
(-2 bps)
8% to 11%
of yield
curve
7-yr
(-51 bps)
50% to 54%
of yield
curve
10-yr
(-77 bps)
66% to 68%
of yield curve
15-yr
(-103 bps)
80% to 80% of
yield curve
15-yr
(-114 bps)
83% to 80% of
yield curve
20-yr
(-123 bps)
91% to 89% of
yield curve
30-yr
(-128 bps)
30-yr
(-125 bps)
20-yr
(-125 bps)
93% to 89% of
yield curve
2-yr
(-2 bps)
8% to 11% of
yield curve
Source: Thomson Municipal Market Monitor (TM3), WFA Municipal Research
Past performance is not an indication of future results.
Figure 3: MMD GO 10YR “Baa” to “AAA” Credit Spread (Oct. 21, 2008– Oct. 21, 2014)
354 bps
@ 3/31/09
(All-time High)
156 bps
@ 1/2/14
(12-Month High)
105 bps
@10/17/14
(Six-Year
Low)
148 bps
@
10/21/08
188 bps
(Six-Year Average Line)
131 bps
@ 5/28/13
Source: Thomson Municipal Market Monitor (TM3)
Past performance is not an indication of future results.
Page 4 of 8
Municipal Market Update
October 22, 2014
Figure 4: MMD “AAA” Muni-to-Treasury Ratios (Oct. 21, 2004 – Oct. 21, 2014)
230%
MMD AAA Municipal / Treasury Bonds
220%
210%
5Muni
10Muni
30Muni
200%
190%
180%
170%
160%
150%
140%
130%
120%
110%
100%
90%
80%
70%
60%
50%
Source: Thomson Municipal Market Monitor (TM3,) October 21, 2014
Past performance is not an indication of future results.
Page 5 of 8
Municipal Market Update
October 22, 2014
Municipal Spread Monitor as of October 21, 2014
Benchmark
2.060
1
Ratings
Yield Spread-to- Spread Change Lowest Spread Highest Spread Average Spread
# BPs Current Spread is # Std Dev Current Spread is
(Moody's/S&P)
Yield
Benchmark3
(Weekly)4
(12-Month)
(12-Month)
(12-Month)
Above or Below Avg.5
Above or Below Avg.6
Aa3/A
Aa1/AA+
Aaa/AAA
Aa3/AAAa1/AAA
A1/A
Aaa/AAA
A3/AAaa/AAA
Aa1/AA+
Aaa/AAA
Aa2/AAAa1/AA+
Aaa/AA+
Aa1/AA+
Aaa/AAA
2.292
2.117
2.092
2.361
2.172
2.578
2.044
3.635
2.051
2.232
2.093
2.357
2.199
2.158
2.178
2.079
23.2
5.7
3.2
30.1
11.2
51.8
-1.6
157.5
-0.9
17.2
3.3
29.7
13.9
9.8
11.8
1.9
3.90
-3.00
0.80
-0.40
-0.20
4.00
1.90
2.10
1.30
-0.50
0.00
-0.30
2.80
-3.40
-0.70
1.70
19.3
3.6
-13.2
5.4
10.3
12
-18.2
108.7
-16.7
11.8
-16.4
27.4
8
-10.6
7.6
-5.5
70.5
41.3
36.2
41.9
47.9
59
15.9
207.4
24.4
43.4
23.2
101.3
36.9
27.5
50
32.9
39.0
19.6
13.8
32.5
24.3
37.2
0.5
146.5
1.0
26.3
6.0
54.5
21.0
7.8
27.3
10.1
-15.81
-13.93
-10.63
-2.41
-13.12
14.64
-2.15
10.97
-1.88
-9.12
-2.67
-24.81
-7.11
1.99
-15.50
-8.17
-1.2
-1.6
-1.3
-0.5
-1.4
1.5
-0.4
0.4
-0.3
-1.4
-0.6
-1.2
-1.1
0.3
-2.1
-1.4
2.560
3.090
3.290
2.690
2.300
3.120
2.880
50.0
103.0
123.0
63.0
24.0
106.0
82.0
-9.40
-9.40
-9.40
-7.40
-9.40
-6.40
-6.40
-14
38
84.5
4.8
-41
33
12
59.6
112.6
142.6
70.4
35.6
114.6
90.6
33.5
86.2
115.2
44.2
3.7
70.2
46.6
16.47
16.85
7.79
18.82
20.29
35.82
35.40
1.0
1.0
0.6
1.3
1.1
2.1
2.2
2
States
California
New York
Texas
Pennsylvania
Florida
New Jersey
North Carolina
Illinois
Virginia
Ohio
Georgia
Michigan
Massachusetts
South Carolina
Washington
Maryland
Sectors7
AA+ general ob
A+ general ob
BBB general ob
Transportation AA+
Education AAA
Healthcare AA
Utilities AA
Source: Bloomberg
1
BVAL Muni 10-Yr Benchmark curve is the baseline curve for BVAL tax-exempt munis. It is populated with high quality US municipal bonds with an average rating of AAA from Moody's and S&P. The yield curve is built using nonparametric fit of market data obtained from the Municipal Securities Rulemaking Board, new issues calendars, and other Bloomberg proprietary contributed prices. Represents 5% couponing.
2
State Specific Yield Curves maturing in approximately 10 years
3
Difference between the state, sector, or credit yield and the benchmark yield, in basis points
4
Bond prices and yields have an inverse relationship. Yield spread changes highlighted in red have widened week-over-week, indicating bond prices have gotten cheaper relative to the benchmark. Yield spread changes highlighted in
green have narrowed week-over-week, indicating bond prices have gotten richer relative to the benchmark.
5
Basis points (bps) highlighted in red are above the 12-month average. Basis points (bps) highlighted in green are below the 12-month average
6
Standard deviations highlighted in red are greater than or equal to two standard deviations above the 12-month average, indicating relative cheapness. Standard deviations highlighted in green are greater than or equal to two
standard deviations below the 12-month average, indicating relative richness. Standard deviations highlighted in yellow are between one and two standard deviations away from the 12-month average, and should be monitored for
relative value.
7
Muni Fair Value Yield Indices maturing in approximately 10 years
Page 6 of 8
Municipal Market Update
October 22, 2014
IMPORTANT DISCLOSURES
Wells Fargo Advisors buys and sells securities discussed in this report on a principal basis.
Disclosure information . . . For important disclosure information, please contact:
Wells Fargo Advisors Attn: Advisory Services (Disclosure Information)
One North Jefferson, St. Louis, MO 63103 Or call phone (888) 410-9203
Please remember to specify the issuer(s) with respect to which you would like to receive disclosure
information.
ANALYST CERTIFICATION: The Analyst who prepared this report hereby certifies that the views expressed
in this report accurately reflect his/her personal views about the subject companies and their securities. The
Analyst also certifies that he/she has not been, is not, and will not be receiving direct or indirect compensation
for expressing the specific recommendation(s) or view(s) in this report.
Disclaimers
Prices and figures are as of the date of publication unless specified otherwise.
Investing in fixed income securities involves certain risks such as market risk if sold prior to maturity and
credit risk, especially if investing in high yield bonds, which have lower ratings and are subject to greater
volatility. All fixed income investments may be worth less than the original cost upon redemption or
maturity. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest
rates can result in the decline of the value of your investment.
Income from municipal securities is generally free from federal taxes and state taxes for residents of the
issuing state. While the interest income is tax-free, capital gains, if any, will be subject to taxes. Income for
some investors may be subject to the federal Alternative Minimum Tax (AMT).
Although Treasuries are considered free from credit risk they are subject to other types of risks. These risks
include interest rate risk, which may cause the underlying value of the bond to fluctuate.
Taxable equivalent Yield (TEY) is the pretax yield that a taxable bond needs to possess for the yield to be
equal to that of a tax-free municipal bond.
Relative Value is a method of determining an asset's value that takes into account the value of similar assets.
Calculations that are used to measure the relative value of stocks include the enterprise ratio and price-toearnings ratio.
Standard deviation of return measures the average deviations of a return series from its mean, and is often
used as a measure of risk. A large standard deviation implies that there have been large swings in the return
series of the manager.
Duration is a measure used to determine a bond/s or bond portfolio’s sensitivity to movements in interest
rates. Generally, the longer the duration the more sensitive a bond or bond portfolio is to changes in interest
rates.
Page 7 of 8
Municipal Market Update
October 22, 2014
Explanation of Moody’s Investors Service (Moody’s), Standard & Poor’s (S&P) and Fitch Ratings (Fitch)
longer-term corporate debt (greater than one year to maturity) rating scales:
Ratings of
Baa3/BBB- or
higher (above the
dotted line) are
considered
investment grade.
Ratings of Ba1/BB+
or lower (below the
dotted line) are
considered high
yield (also known
as junk bonds).
Moody's
S&P/
Fitch
Aaa
Aa1
Aa2
Aa3
AAA
AA+
AA
AA-
A1
A2
A3
A+
A
A-
The highest quality debt, with minimal credit risk.
High quality and subject to very low credit risk.
Upper-medium grade and subject to low credit risk.
Baa1
BBB+
Baa2
BBB
Subject to moderate credit risk; considered medium-grade, and
Baa3
BBBas such may possess certain speculative characteristics.
---------------------------------------------------------------------------------------------------Ba1
BB+
Ba2
BB
Judged to have speculative elements; subject to substantial credit risk.
Ba3
BBB1
B2
B3
B+
B
B-
Considered speculative and are subject to high credit risk.
Caa1
Caa2
Caa3
CCC+
CCC
CCC-
Judged to be of poor standing and are subject to very high credit risk.
Ca
CC
Highly speculative and are likely in, or very near, default with some
prospect of recovery of principal and interest.
C
C
The lowest rate class of bonds; these obligations are typically in
default with little prospect for recovery.
S&P National AMT-Free Municipal Bond Index is a broad, comprehensive, market value-weighted index
designed to measure the performance of the investment-grade tax-exempt U.S. municipal bond market.
An index is unmanaged and not available for direct investment.
Wells Fargo Advisors research analysts receive no compensation in connection with the firm’s investment
banking business. Analysts may be eligible for annual bonus compensation based on the overall profitability
of the firm, which takes into account revenues derived from all the firm’s business activities, including its
investment banking business.
Additional information available upon request. Past performance is not a guide to future performance. The
material contained herein has been prepared from sources and data we believe to be reliable but we make no
guarantee as to its accuracy or completeness. This material is published solely for informational purposes
and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or investment product.
Opinions and estimates are as of a certain date and subject to change without notice.
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Company. First Clearing, LLC Member SIPC is a registered broker dealer and non-bank affiliate of Wells Fargo & Company. ©2014 Wells Fargo Advisors, LLC. All rights reserved.
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