At the height of market volatility in March, long corporate and taxable municipal bond spreads gapped out over 100 basis points (bps). The recovery in spreads has been more pronounced in corporate bonds, with the Federal Reserve (Fed) now purchasing corporate credit both directly and through exchange-traded funds. While direct Fed purchases are reserved for bonds inside a five-year maturity, the support has firmed up corporate credit curves broadly.
This week’s chart shows the movement in the Bloomberg Barclays Long Corporate Bond Index rated single-A and higher relative to the Bloomberg Barclays Taxable Municipal Aggregate Eligible Index (both indices are high quality with a similar duration profile). Certainly, both corporates and taxable municipal bonds offered compelling value at the end of March as liquidity was extremely challenged. In the weeks that followed, corporates have outperformed. While taxable municipals typically trade slightly cheaper than high-quality corporates, largely due to lower liquidity, the opportunity to add cheap taxable municipal bonds existed for several weeks. In fact, taxable municipals were almost 65 bps cheaper than corporate alternatives in mid-April. This basis has slowly compressed and is now inside 30 bps.
Part of the initial underperformance in taxable municipals has been due to the large increase in issuance in this paper. As rates have fallen to near-record lows, many municipal issuers have opted to issue in taxable form rather than in tax-exempt securities, which are more limiting in how the funds can be utilized. Taxable municipal issuance is projected to be the largest we have experienced in 10 years.
The Fed has provided municipal issuers with support in the form of a Municipal Liquidity Facility backstop, making $500 billion available to issuers as a last resort. However, the Fed is not directly purchasing municipal securities as it is corporate bonds.
The taxable municipal sector provides select opportunities for value relative to high-quality long corporate alternatives following the volatility experienced in mid-March. The Fed support in the corporate market has firmed up the sector, quickly leading to outperformance relative to taxable municipals. While municipal bonds have historically had much lower default rates than corporates, issuers will be confronted with several years of credit challenges following the pandemic and shutdown. Revenues are expected to be significantly lower for municipal issuers and those entities that entered these uncertain times on sound footing will be better able to weather the storm.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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