Municipal Market Performance and Benchmark Rates: Volatility persisted in fixed income markets through Janaury although yield levels ended the month close to where they began. 10-year AAA municipal rates closed the month 3 bps lower than they opened by rallying 25 bps off the high yields mid-month. 30-year AAA municipal rates closed the month 1 bps higher by rallying 18 bps off the mid-month highs. Both the investment grade and high yield indices posted positive performance for the month, 0.51% and 0.76%, respectively. The reversal in fund flows mid-month was the primary driver of market performance as demand was able to absorb the heightened new issue volume in January.Mutual
Fund Flows: As noted above, fund flows turned strongly positive the last two weeks of January, reversing the negative trend exhibited since early December 2024. Strong retail fund flows set the foundation for strong market performance the later half of January. Notable within the fund flow data was the balance between investment grade and high yield funds. We estimate the high yield market constitutes approximately 18% of the total tax-exempt municipal market. To garner 50% of total fund flows highlights the attractiveness of absolute yield levels in the high yield market. Despite spreads being “tight” the availability of historically attractive long-term yields continues to attract disproportionate fund flows and drive sector out-performance.
Primary Market Supply: Municipal market new issue supply is generally fairly anemic in January as governmental entities are returning to work from the holidays or transitioning to new leadership. However, January 2025 volume was up nearly 11% vs. 2024 and exceeded the 10-year average by 23%. The increased new issue volume is likely the result of 2 components: Excess supply from Q4-2024 and issuer interest in getting ahead of any changes to federal tax and spending policies associated with the new adminstration. As we noted throughout 2024, new issue volume was muted through the first 6 months of the year as borrowers were looking for the Federal Reserve to initiate anticipated easing. As a result, the 2nd half of 2024 saw significantly increased supply that likely carried into January. Additionally, the new administration has been busy making proposals that could have significant impact on the municipal bond market and are likely to increase market volatility, if nothing else. We expect high new issue volume levels to persist given the uncertainty of future federal tax and spending policies.
January is typically a fairly quiet month in the municipal bond market. The municipal market seems to take it’s time getting back to normal after the holiday season. Lower volume combined with significant coupon and maturity reinvestment (a unique municipal market phenomenon given the retail nature of the market) have historically led to solid market performance in January. This January was anything but quiet. The transition to a new government mid-month and subsequent proposals and executive orders have raised a lot of questions from investors, issuers and all municipal market participants.
Clearly, the most significant proposal for the municipal bond market came from the Ways and Means Committee in a 51-page list of targeted programs, policies and plans that could be implemented in a reconciliation bill to offset the projected costs associated with extending the 2017 Tax Cuts and Jobs Act (TCJA). Many of the TCJA provisions are set to expire on December 31, 2025, which President Trump promised to extend during the presidential campaign. Among the 200+ proposals was the elimination of exclusion of interest on state and local bonds and ending tax preference for private activity bonds. Total 10-year savings estimated to be $250 and $114 billion, respectively. While tax-exemption for municipal bonds has attracted the attention of congressional leaders since 1986, this represents the most pronounced and direct attack, yet. While the cost savings are significant, municipal market stakeholders have always been effective in lobbying for the market’s interest in preserving tax-exemption. Interestingly, the rationale has shifted from a constitutional protection to an economic cost/benefit analysis. Should the proposal to eliminate exclusion of interest and tax preference move from a distributed list among committee members to an actual proposal for reconciliation we expect significant lobbying efforts from market participants including: City, State and Local governmental officials, non-profit borrowers (hospitals, colleges, universities, charter schools and other service providers) and holders of $3.4 trillion of outstanding tax-exempt debt.
Given the narrow majorities in both the House and Senate, such legislation seems unlikely to pass particularly given the tax burden will shift from the federal government to state and local governments in the form of substantially higher borrowing costs. Those costs, of course, are passed along to ALL citizens in the form of property taxes, use taxes and income taxes. However, anything is possible, particularly if Congressional leaders find the fortitude to work together for something BIG in which everyone loses something. Needless to say, we will be keeping a close eye on actual proposals as they are put forward.
There are other proposals among the 200+ in the list that have an impact, albeit much smaller, on the municipal market. Included among them is the elimination of non-profit status for hospital ($260 billion in 10-year savings). This option would tax hospitals as for-profit businesses and could have impact on local finances if this would put these hospitals on property tax rolls. Increasing the endowment tax for colleges and universities as well as repeal of SALT deductions are also among the proposals.
The Ways and Means Committee has presented a laundry list of options to offset the costs of TCJA extension that in total, would impact every US citizen. What comes out of the Committee remains to be seen, but is definitely worth following, and we will.
Lind Capital Partners Non-Rated Market Strategy (through December 31, 2024)
The chart above shows the increase in value of $1,000,000 invested in the LCP composite at inception (net of management fees and expenses) vs. the benchmark, the Bloomberg High Yield Muni (LMHYTR) as well as the Bloomberg Muni (LMBITR) indices (it is not possible to invest in either Bloomberg Index). Please contact us with questions regarding credit profile, returns, taxable equivalent yields or further portfolio information. Past performance is not indicative of future results.