Hi, I'm Ann Ferentino, a Portfolio Manager and Credit Analyst at Federated Investors.
How did the 2018 tax reform impact the municipal bond market?
In the wake of the tax reform in 2018, municipal bonds are outperforming relative to most other fixed income asset classes and that's what we expected. In fact, not only are we outperforming, but munis have actually, if you look at the Barclay's Muni Bond Index, it's actually produced positive total return for the year. It's up 78 basis points. This is compared to the Barclay's Agg which is down a little over one percent. Corporate bonds are down over three and even high-yield corporates are down, or have negative returns for the year. So we are seeing positive returns. The reason that we're seeing positive returns in a generally rising rate environment is because of the tax reform. It has positively impacted the supply demand dynamic within our market. On the supply side it's reduced supply significantly because it eliminated advanced refundings. Advanced refundings are a way for issuers to refinance their debt before the call date, and therefore supply is down around eight percent year to date. The tax bill has also been feeding demand for the retail investors who are looking for tax protection now that they have a cap on their federal deductions for state and local taxes.
What happened to the muni market as U.S. banks reduced their exposure?
So as a result of the tax bill, the corporate tax rate was reduced from 35 percent to 21 percent. Now, a third of the muni market, the 3.8 trillion market, is made up of banks and insurance companies who hold munis on their balance sheets. And we have seen a reduction in demand from banks and insurance companies. They have been selling munis, however it wasn't all at once. It wasn't that the bill was passed and they came out in the beginning of the year and sold all their munis. It's happened gradually and as a result, it hasn't impacted our market all that much because the slack in demand has really been made up by the retail investor who, like I said, is taking advantage of munis because of the reduction in their ability to write off their state and local taxes. They have seen a reduction in their income tax rates and the brackets have changed but it hasn't been enough for them to not still have strong demand from munis.
Views are as of Dec. 7, 2018, and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector. Past performance is no guarantee of future results. Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices. Income from municipal securities may be subject to the federal Alternative Minimum Tax (AMT) and state and local taxes. Bloomberg Barclays Municipal Bond Index: Is a market-value-weighted index for the long-term tax-exempt bond market. Bloomberg Barclays U.S. Aggregate Bond Index: Is an unmanaged index composed of securities from the Bloomberg Barclays Government/Corporate Bond Index. Mortgage Backed Securities Index and the Asset Backed Securities Index. Indexes are unmanaged and an investor cannot invest in a index. Diversification does not guarantee a profit nor protect against loss. Federated Investment Management Company 18-76963 (12/18)