Muni Bonds Enjoy Historic Run Despite Tax Overhaul -- Update

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03/06/2019 | 10:42 pm

By Gunjan Banerji

Municipal bonds are enjoying their strongest start to a year since at least 2006, defying expectations that President Trump's sweeping tax overhaul would depress demand in the market.

Investors poured more than $15 billion into municipal bond funds in the first eight weeks of the year, the most over that period in at least 13 years, according to research firm Municipal Market Analytics.

Many had expected Mr. Trump's tax changes in 2017, which cut corporate levies to the lowest point since 1939 and lowered individual taxes for many households, to reduce the market's appeal. Muni bonds are often exempt from federal taxes, making them valuable to people seeking tax-free investment income.

Instead, the muni market has remained popular. Mr. Trump's tax law also capped the deductibility of state and local taxes at $10,000 a year, leading some investors to turn to the market, analysts say, with demand especially robust in states with higher tax rates like California and New York. Taxpayers are filing the first individual returns under the new system this year.

"People are realizing municipal bonds are one of the easiest and the few remaining tax shelters out there," said Rob Wimmel, a portfolio manager at BMO Global Asset Management.

The renewed demand after a tepid 2018 has led to higher bond prices, pushing yields lower.

The yield on the Bloomberg Barclays Municipal Bond Index has fallen in 2019 and reached the lowest level in more than a year on Feb. 26, FactSet data show.

"There has been increased demand in some of the high-tax states," said Steve Cavalier, managing director of municipal underwriting at Piper Jaffray & Co. "The deals so far this year -- they've all done well."

In one sign of enthusiasm for fresh borrowings, orders on some new deals have outstripped supply, traders said.

Mr. Wimmel said he recently tried to buy short-term debt issued by the financially troubled Chicago Board of Education. The school system has a noninvestment grade rating by Moody's Corp. and S&P Global Inc. Competition was so fierce that he says he doubled his initial order of the bonds to ensure he could buy a piece of the deal. He ended up landing about a fifth of the amount he actually wanted, he said.

Investors around the globe have also turned to munis in recent years as interest rates have stayed low, analysts said. Meanwhile, many money managers remain uneasy about volatility in the stock market after the swoon in share prices late last year, according to analysts. Though equities have rebounded so far in 2019, concerns remain about global economic growth and how much longer the decade-old bull market can go on.

Muni debt is traditionally considered safer than other assets like stocks because it is backed by a state or local government's ability to levy taxes or by some revenue linked to essential services such as water or sewage. Though concerns have been rising in recent years over how much some municipalities have in unfunded pension liabilities, the market tends to have relatively low default rates.

While munis are typically known for their stability rather than outsize returns, they outperformed Treasurys and investment-grade corporate debt in 2018 for the first time in three years. They have returned 2.5% since the beginning of 2018, including price changes and interest payments, higher than the 1% return for Treasurys, according to Bloomberg Barclays data via FactSet as of March4. Investment-grade corporate bonds have gained 0.1% since then.

"People tend to look in the rearview mirror and munis were one of the best-performing fixed income asset classes last year," said Hugh McGuirk, a portfolio manager overseeing munis at T.Rowe Price.

But the muni bond rally could soon stall, several analysts said. A ratio comparing the yields on munis maturing in 10 years with comparable Treasurys recently fell to the lowest level since March 2010, Refinitiv data show.

Investors often weigh relative yields of munis and Treasurys to determine where to place their cash. A lower ratio means muni yields are growing less attractive.

Municipals are currently "more vulnerable to swings in the Treasury market," said Robert Amodeo, head of municipals at Western Asset Management, particularly for bonds maturing sooner. "If the U.S. Treasury market cheapens significantly, municipal bonds have less cushion to weather those types of storms."

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