MacKay Municipal Managers announces top five municipal market insights for 2018: A year of return and risk.
NEW YORK, January 22, 2018—MacKay Municipal Managers TM, the municipal bond team of fixed income and equity investment management firm MacKay Shields LLC, today announced its top five insights for the municipal bond market in 2018. John Loffredo and Robert DiMella, co-heads of MacKay Shields Municipal Managers, commented on the firm’s outlook:
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“2018 will be a year of both returns and risks. The traditional approach of being a passive investor focused solely on income is no longer suitable. Tax reform and new regulatory policies will present investment opportunities for well-positioned municipal investors, but also increase the risk for those who fail to adjust to the new investment environment. We believe an active investment strategy based on fundamental research will be the most prudent approach in this environment.”
MacKay Municipal Managers Top Five Municipal Market Insights – 2018
- Taxable Municipal Issuance Accelerates. We expect taxable municipal issuance could double to approximately $60B annually. We believe that low rates, tight credit spreads and demand for yield should keep taxable municipal yields low. Issuers will likely refinance their higher cost tax-exempt debt with taxable municipal bonds, overcoming the elimination of tax-exempt financed advance refundings by the Tax Cuts and Jobs Act of 2017. The increased volume of taxable municipal bonds should broaden the investor base for these securities, increase liquidity, and provide attractive yield opportunities. Individual investors in high tax states where the top marginal rate is quickly reached may also find in-state taxable municipal bonds, still exempt at the state level, to be attractive.
- High Yield Municipal Bonds’ Outperformance Continues. We anticipate that favorable technical and improving fundamental conditions will result in tighter high yield municipal credit spreads and outperformance relative to investment grade municipal bonds. Tax reform will likely reduce tax exempt issuance by around 30%, while at the same time we believe that individual investor and mutual fund manager demand remains strong. We believe ongoing economic expansion and increasing tax revenues, especially excise taxes, should improve coverage ratios for dedicated tax bonds. Stronger credit fundamentals should result in tighter spreads as investor comfort with high yield increases. However, 2018 implementation of the SEC’s rule governing liquidity risk for mutual funds and exchange-traded funds will likely result in the underperformance of non-rated municipal debt as the rule favors frequently traded bonds with published ratings and proven price transparency.
- Intermediate Municipal Bonds Underperform. Low yields, interest rate sensitivity, correlation to Treasury yields, and curve flattening will, in our opinion, result in underperformance of higher quality intermediate municipal bonds. We anticipate higher short-term yields and diminished demand in intermediate municipal bonds by banks and property and casualty insurance companies will lead to a flatter curve. Investors should benefit from higher income, better total return potential, and improved liquidity of alternatives to the intermediate portion of the municipal curve.
- Tax-Exempt Municipal/Treasury Ratios Hit 20-Year Lows. We expect that Municipal/Treasury yield ratios will decline due to supply/demand technicals and improving fundamental conditions. As a result, we anticipate that tax-exempt municipal bonds will outperform Treasury bonds and other high-quality taxable bonds. We look to the 2017 tax law changes to increase demand for income exempt at both the federal and state levels and reduce tax-exempt supply. In high tax states, the relative outperformance of tax-exempt bonds will be particularly impactful.
- Tax-Exempt Market Liquidity Declines. We believe that liquidity for tax-exempt municipals will decline and volatility will rise. Lower corporate tax rates will reduce the profitability of trading tax-exempt debt for broker-dealers, leading to a reduction in trading capital committed to the municipal market. As a result, they will likely redeploy capital into the taxable markets to generate trading profits. For capital still committed to the municipal market, we expect broker-dealers to prefer rated, liquid names as the capital cost of positioning non-rated paper will be prohibitive. As a result, non-rated bonds will trade primarily on an agency basis, where the broker will only transact with the seller and buyer simultaneously. We believe this will further reduce their liquidity and, most likely, value.
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About MacKay Shields LLC
MacKay Shields LLC (“MacKay”) is an indirect wholly-owned subsidiary of New York Life Insurance Company and a wholly-owned subsidiary of New York Life Investment Management Holdings LLC. MacKay is a fixed-income and equity investment management firm with $113 billion in assets under management as of November 30, 2017. Assets under management reflects the addition of Cornerstone Capital Management Holdings LLC’s investment teams that joined MacKay on January 1, 2018. MacKay manages fixed income and equity strategies for high-net worth individuals, institutional clients, and mutual funds.