skip navigation

Blog

Stay up to date on timely topics and market events. Subscribe to our Blog now.

MARKETS
January 12, 2021

Weekly Municipal Monitor—Implications of a Unified Government

By Robert E. Amodeo, Michael Linko

Stay up to date on timely topics and market events. Subscribe to our Blog now.

Municipals Outperformed Treasuries

Municipal yields moved higher across the curve, but outperformed the heavy Treasury selloff during the week. Municipal mutual funds recorded a ninth consecutive week of inflows. AAA municipal yields moved 4-7 bps higher across the curve. Both 5- and 10-year Municipal/Treasury ratios touched record lows amid the Treasury selloff. The Bloomberg Barclays Municipal Index returned -0.09%, while the HY Muni Index returned 0.72% as credit spreads tightened due to increased stimulus hopes. Following the Georgia Senate runoffs, we evaluate the implications of a unified government.

Municipal Technicals Remain Strong, Supported by Positive Fund Flows

Fund Flows: Municipal mutual funds recorded a ninth consecutive week of inflows during the week ending January 6, reporting $1.1 billion of net inflows according to Lipper. Long-term funds recorded $465 million of inflows, intermediate funds recorded $150 million of inflows and high-yield funds recorded $98 million of inflows.

Supply: The muni market recorded $3.5 billion of new-issue volume during the first week of the year, and keeping pace with recent trends, one-third of issuance was in the form of taxable issuance. This week’s new-issue calendar is expected to increase to $7.8 billion (+123% week-over-week). The largest deals include $1.3 billion Baylor Scott & White and $651 million Columbus, Ohio general obligation transactions.

This Week in Munis: Implications of a Unified Government

  • As we close a tumultuous election season, Democrats’ gaining control of two Senate seats from Georgia will likely have implications for the broader municipal market due to increased prospects of state and local aid, infrastructure initiatives and higher tax rates.

  • Direct aid to state and local governments to solve for revenue shortfalls was a controversial issue in prior federal support packages. We expect this to be revisited in the early stages of the new administration as states and localities continue to grapple with sizeable budget gaps. Democrats had favored the measure, which would be positive for municipal credit, particularly among stressed segments of the market.

  • Infrastructure is one of the few bipartisan issues Congress may attempt to address in the upcoming session, and the Biden administration may look to a Build America Bond-like solution to support the recovery from the current pandemic, similar to what was achieved during the Obama administration. A federally subsidized taxable debt program would incentivize additional taxable issuance, potentially providing value to a global investor base while creating additional scarcity value of tax-exempt income producing assets.

  • Increases in higher marginal tax rates are more likely under a Democrat-controlled government, which would increase the relative value of tax-exempt income. Biden has advocated for increasing the highest marginal individual tax rates to 39.6% from 37.0%. The Biden plan also calls for raising the corporate tax rate from 21% to 28%, which would likely attract additional demand from institutions such as banks and insurance companies.

  • While all of these measures would be significant and constructive for the municipal market from demand and credit perspectives, we believe Washington policy moves slower than headlines may suggest. We expect the focus of the new administration and Congress to prioritize additional aid and stimulus initiatives to support the economy through the pandemic, ahead of major tax reform initiatives.

Exhibit 1: Municipal Bond Yields and Index Return
Explore Municipal Bond Yields and Index Return.
Sources: (A) Muni yields: Thomson Reuters MMD; Treasury Yields: Bloomberg. As of 08 Jan 21. (B) Bloomberg. As of 08 Jan 21. Select the image to expand the view.
Exhibit 2: Tax-Exempt and Taxable Municipal Valuations
Explore Tax-Exempt and Taxable Municipal Valuations.
Sources: (A) Bloomberg, Western Asset. AAA, AA, A, BBB Corporate Indices. After-tax yield assumes a top effective tax rate of 40.8%. As of 08 Jan 21.
(B) Bloomberg, Western Asset; Taxable Muni Index Corporate comparable used is the long corporate (ex. BBB) to better align credit quality and duration. As of 08 Jan 21.
© Western Asset Management Company, LLC 2021. This publication is the property of Western Asset and is intended for the sole use of its clients, consultants, and other intended recipients. It should not be forwarded to any other person. Contents herein should be treated as confidential and proprietary information. This material may not be reproduced or used in any form or medium without express written permission.
Past results are not indicative of future investment results. This publication is for informational purposes only and reflects the current opinions of Western Asset. Information contained herein is believed to be accurate, but cannot be guaranteed. Opinions represented are not intended as an offer or solicitation with respect to the purchase or sale of any security and are subject to change without notice. Statements in this material should not be considered investment advice. Employees and/or clients of Western Asset may have a position in the securities mentioned. This publication has been prepared without taking into account your objectives, financial situation or needs. Before acting on this information, you should consider its appropriateness having regard to your objectives, financial situation or needs. It is your responsibility to be aware of and observe the applicable laws and regulations of your country of residence.
Western Asset Management Company Distribuidora de Títulos e Valores Mobiliários Limitada is authorised and regulated by Comissão de Valores Mobiliários and Banco Central do Brasil. Western Asset Management Company Pty Ltd ABN 41 117 767 923 is the holder of the Australian Financial Services Licence 303160. Western Asset Management Company Pte. Ltd. Co. Reg. No. 200007692R is a holder of a Capital Markets Services Licence for fund management and regulated by the Monetary Authority of Singapore. Western Asset Management Company Ltd is a registered Financial Instruments Business Operator and regulated by the Financial Services Agency of Japan. Western Asset Management Company Limited is authorised and regulated by the Financial Conduct Authority (“FCA”). This communication is intended for distribution to Professional Clients only if deemed to be a financial promotion in the UK and EEA countries as defined by the FCA or MiFID II rules.