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ECONOMY
19 March 2024

Weekly Municipal Monitor—Wealth Boom Bodes Well for Muni Demand

By Sam Weitzman
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Municipals Posted Negative Returns Last Week

Munis posted negative returns last week and outperformed Treasuries, as Treasury yields moved higher on stronger-than-anticipated core Consumer Price Index (CPI) and Producer Price Index (PPI) data. High-grade muni yields moved higher across the yield curve, and technicals improved as municipal mutual funds recorded inflows. The Bloomberg Municipal Index returned -0.07% during the week, the High Yield Muni Index returned 0.16% and the Taxable Muni Index returned -1.46%. This week we highlight wealth trends from recent IRS data.

Fund Flows and Supply Levels Continued to Move Higher

Fund Flows: During the week ending March 16, weekly reporting municipal mutual funds recorded $295 million of net inflows, according to Lipper. Long-term funds recorded $315 million of inflows, intermediate funds recorded $25 million of inflows and high-yield funds recorded $279 million of inflows. Short-term funds recorded $52 million of outflows. This week’s inflows lead estimated year-to-date (YTD) net inflows higher to $4.6 billion.

Supply: The muni market recorded $10 billion of new-issue volume last week, up 10% from the prior week. YTD issuance of $83 billion is 38% higher than last year’s level, with tax-exempt issuance 52% higher and taxable issuance 48% lower year-over-year (YoY). This week’s calendar is expected to decline to $7.5 billion. Largest deals include $1.2 billion NY Metropolitan Transportation Authority (MTA) and $770 million Florida Development Corp transactions.

This Week in Munis: Wealth Boom Bodes Well for Muni Demand

Recently released IRS income data for the 2021 tax year highlights overall income and wealth trends across the US. For the municipal market, this reported income data across tax brackets and states provides insight into tax collections and taxing power for municipalities, a key gauge of credit health. From a market technicals perspective, income trends also inform the composition of potential demand for municipal securities, not only shedding light on the number of taxpayers that can benefit from the municipal tax exemption, but also in which states demand could be highest.

Exhibit 1: US Adjusted Gross Income (AGI) by Year
Explore US Adjusted Gross Income (AGI) by Year
Source: US Internal Revenue Service (IRS). IRS data for tax years 2001-2021. As of 27 Feb 24. Select the image to expand the view.

As economies continued to recover from the pandemic drawdowns and as the labor market strengthened, adjusted gross income (AGI) in the US increased $2.2 trillion in 2021 (or 17.7% YoY), marking the highest YoY increase in AGI over the past 20 years (Exhibit 1). AGI growth in 2021 was widespread across states, led by Wyoming (27%), Nevada (26%) and Montana (22%). New York, often maligned for domestic outmigration issues, recorded 22% growth in AGI, ranking fifth among states (Exhibit 2).

Exhibit 2: US Adjusted Gross Income (AGI) and YoY Growth by State
Explore US Adjusted Gross Income (AGI) and YoY Growth by State
Source: US Internal Revenue Service (IRS). IRS data for tax year 2021. As of 27 Feb 24. Select the image to expand the view.

Improving overall wealth levels supported a decline of filers in the lowest marginal tax brackets and an increase in filers subject to higher tax rates. Filers with an annual AGI below $50,000 declined 4% to 34% across income cohorts. Meanwhile, filers with AGIs over $500,000, who benefit the most from the municipal tax exemption given relatively higher tax rates, increased 32% to 44%.

Exhibit 3: Number of Returns by Tax Bracket, 2020 vs. 2021
Explore Number of Returns by Tax Bracket, 2020 vs. 2021
Source: Western Asset. IRS data for tax years 2020 and 2021. As of 27 Feb 24. Select the image to expand the view.

Growth of high-income earners was widespread, similar to national trends. Louisiana (+59% YoY), Montana (+55%) and Hawaii (+54%), recorded the highest YoY growth rates of high-income filers. Meanwhile, California (+117,000 filers), Texas (+53,000 filers), and New York (+47,000 filers), recorded the strongest growth by number of filers.

Exhibit 4: Growth of High-Income Earners ($500k+) by State
Explore Growth of High-Income Earners ($500k+) by State
Source: Western Asset. IRS data for tax year 2021. As of 27 Feb 24. Select the image to expand the view.

Domestic migration and population trends across states often contribute to headlines that point to credit concerns for municipalities. However, population changes only consider a single component of a municipal tax base that can support tax revenues and credit quality. Wealth levels are a key driver of taxing power for state and local governments, and this IRS release is an example of recent strength that has supported recent record high tax collections and favorable municipal credit quality. As income trends and tax rates both move higher for many, Western Asset believes that municipals will offer value for a greater number of individuals going forward.

Municipal Credit Curves and Relative Value

Exhibit 5: Muni Credit Curves
Explore Muni Credit Curves
Source: Bloomberg, Western Asset. As of 15 Mar 24. Bloomberg BVAL Municipal Credit Indices (AAA, AA, A, BBB, respectively) and US Sovereign Curves. Taxable-Equivalent Muni Credit Curves consider the top marginal effective tax rate of 40.8%. Select the image to expand the view.
Exhibit 6: Taxable-Equivalent Muni Credit Curves
Explore Taxable-Equivalent Muni Credit Curves
Source: Bloomberg, Western Asset. As of 15 Mar 24. Bloomberg BVAL Municipal Credit Indices (AAA, AA, A, BBB, respectively) and US Sovereign Curves. Taxable-Equivalent Muni Credit Curves consider the top marginal effective tax rate of 40.8%. Select the image to expand the view.
Exhibit 7: AAA Munis versus Treasuries
Explore AAA Munis versus Treasuries
Source: Muni Yields: Thomson Reuters MMD, Treasury Yields: Bloomberg. As of 15 Mar 24. Past performance is not a guarantee of future results. It is not possible to invest directly in an Index. Select the image to expand the view.
Exhibit 8: Tax-Exempt and Taxable Muni Valuations
Explore Tax-Exempt and Taxable Muni Valuations
Source: Bloomberg. Yield-to-worst (YTW) is the lowest potential yield that can be received on a bond without the issuer actually defaulting. As of 15 Mar 24. Select the image to expand the view.

Western Asset Key Themes for Muni Investors

Theme #1: Municipal taxable-equivalent yields are above decade averages.

Exhibit 9: Muni and Taxable-Equivalent Muni Yield-to-Worst
Explore Muni and Taxable-Equivalent Muni Yield-to-Worst
Source: Bloomberg, Western Asset. As of 15 Mar 24. Bloomberg Municipal Bond Index Yield Considering Highest Marginal Tax Rate of 40.8%. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results. Select the image to expand the view.

Theme #2: Recent yield-curve steepening has highlighted relative value in longer maturities.

Exhibit 10: AAA Municipal vs. Treasury Yield Curves
AAA Municipal vs. Treasury Yield Curves
Source: Bloomberg, Western Asset. As of 15 Mar 24. Bloomberg Valuation Service (BVAL) AAA Muni Curve and US On-/Off-the-Run Sovereign Curve. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results. Select the image to expand the view.

Theme #3: Munis offer attractive after-tax yield pickup versus long Treasuries and corporate credit.

Exhibit 11: Municipal vs. Taxable Fixed-Income Yields by Quality
Explore Municipal vs. Taxable Fixed-Income Yields by Quality
Source: Western Asset, Bloomberg. As 08 Mar 24. 10- and 30-Year comparison reflects Bloomberg Valuation Service (BVAL) AAA Muni Curve and US On-/Off-the-Run Sovereign Curve. AA Muni reflects the Bloomberg AA Muni Bond Index. A Muni reflects the Bloomberg A Muni Bond Index. BBB Muni reflects the Bloomberg BBB Muni Bond Index. HY Muni reflects the Bloomberg High Yield Muni Bond Index. AA Corp reflects the Bloomberg AA Corporate Bond Index. A Corp reflects the Bloomberg A Corporate Bond Index. BBB Corp reflects the Bloomberg BBB Corporate Bond Index. After-tax yield considers top marginal tax rate of 40.8%. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results. Select the image to expand the view.

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