Monthly Municipal Market Update
Robert W. Baird & Co. Public Finance
June 2015
In this month’s issue, we discuss the following headlines:
• Interest rates were volatile throughout May, reaching highs for the year
• Supply pace decreased versus prior months, but remains strong as demand slightly weakens
• Bank qualified bonds remain attractive, generating savings along the middle of the yield
curve compared to non-bank qualified bonds
• The Fed’s June meeting – what to expect
Exhibit 1. Yields Spiked Mid-May to a 2015 High
2.30
MMD (%)
Interest Rates Saw Much Volatility
Volatility was once again the theme for interest
rates in May, as demonstrated in Exhibit 1. As the
month unfolded, taxable U.S. Treasury yields
began to rise in response to turmoil in the global
bond markets. Following suit, tax-exempt MMD
yields likewise began creeping up.
2.25
2.20
2.15
After a brief correction during the second week of
10 YR MMD
10 YR US TSY
2.10
May, a heavy slate of new issue corporate bonds
5/1 5/3 5/5 5/7 5/9 5/11 5/13 5/15 5/17 5/19 5/21 5/23 5/25 5/27 5/29
pushed U.S. Treasury yields higher once again.
This rise in taxable interest rates supported their continued march upward, with the MMD peaking on May 20th.
However, after the release of the Federal Open Market Committee’s (FOMC) April meeting minutes, longer-dated
taxable and taxable rates began drifting lower and continued to decline through month-end.
Exhibit 2. 2015 Muni Market Update
Taxable and tax-exempt interest rates both hit
MMD (%)
UST Yield (%)
highs for the year during May. However, the
Min
Max
Avg
5/29
Min
Max
Avg
short end of the tax-exempt yield curve was hit
2 YR
0.41
0.62
0.50
0.62
0.44
0.73
0.59
particularly hard: the 5-YR MMD, for example,
5 YR
0.94
1.45
1.22
1.41
1.18
1.70
1.45
10 YR
1.72
2.32
2.01
2.19
1.68
2.28
2.01
rose to 1.45%, its highest level since August 2013
30 YR
2.50
3.30
2.87
3.16
2.25
3.07
2.64
(see Exhibit 2). Not only did shorter tax-exempt
yields hit yearly highs in May, but they also closed out the month near or at those highs.
5/29
0.61
1.49
2.12
2.88
As Exhibit 3 shows, tax-exempt rates during 2015
Exhibit 3. MMD Spreads From High to Low From January to May in Basis Points
changed dramatically, with high-to-low spreads
2 YR
5 YR
10 YR
30 YR
2012
16
37
66
49
for the 2-, 5-, 10- and 30-YR MMD of 21, 51, 60
2013
8
22
44
53
and 80 basis points, respectively. Compared to
2014
14
38
65
98
previous years, these spreads are significant,
2015
21
51
60
80
particularly in shorter maturities (i.e., a flattening
yield curve). As we enter June, the pendulum appears to be swinging back, with rates beginning to climb.
Exhibit 4. Municipal Supply Weakening Entering Into June
16.0
14.0
1.0
12.0
0.5
10.0
8.0
0.0
6.0
-0.5
4.0
-1.0
2.0
30-Day Visible Supply
Muni Flow of Funds
5/27
5/20
5/7
5/13
4/29
4/22
4/8
4/15
4/1
3/25
3/18
3/4
3/12
2/25
2/18
2/4
2/11
1/28
1/21
-1.5
1/7
0.0
Flow of Funds $Billions
1.5
1/14
30-Day Supply $Billions
Muni Supply “Normalizes” as Demand Wanes
Outflows occurred consistently throughout May
as supply reached yearly highs during the second
week of the month (see Exhibit 4). Overall, May
volume was up 15%, less than the year-over-year
gains of 39%, 79%, 44% and 42% during January
to April. Municipal outflows, though minor, were
consistent throughout May, signaling a lack of
demand. June has typically been the largest
month of issuance (over $17.4 billion maturing
and $17.8 billion called, according to Bloomberg),
but the influx in volume over the past five
months combined with rising interest rates may
curtail June’s volume to below-average levels.
Bank Qualified Bonds See Attractive Spreads
In this rising-interest-rate environment, small issuers
should consider taking advantage of bank qualified (BQ)
designation bonds if possible. Banks that purchase BQ
bonds can deduct 80% of their carrying costs, the interest
expense they incur from purchasing or carrying an
inventory of tax-exempt bonds.
Bonds meeting bank qualified status require issuers to
limit bond financings to $10 million per year. However, as
Exhibit 5 shows, the spread between BQ and non-BQ
bonds is as high as 65 basis points, which may generate
significant interest rate savings for a BQ structure.
4.00
Exhibit 5. BQ Rates Are 41 Basis Points Lower
(on Average) Than NBQ Rates
-- "Aa2" Rating Assumed --
3.50
3.00
2.50
Spreads between BQ and
NBQ reach up to 65 basis
points in the middle of the
curve.
2.00
1.50
1.00
0.50
BQ
NBQ
0.00
2015 2017 2019 2021 2023 2025 2027 2029 2031 2033 2035
Bank qualified bonds currently comprise approximately
46% of all municipal bonds issued. Recent legislation has been introduced to increase the BQ annual issuance limit to
$30 million (the American Recovery and Reinvestment Act temporary increased the limit from $10 to $30 million from
2009 to 2010), and to apply the limit to 501(c)(3) nonprofit issuers.
The June Fed Meeting – What to Expect
The market’s guessing game continues over when the Fed will move from the zero-range-bound Fed funds target rate
(0.00 to 0.25%) it has held since December 2008. Recent comments from Fed Chair Janet Yellen indicate they will likely
raise interest rates this year for the first time since May 2006. Yellen also noted the recent slowdown in U.S. economic
activity would not change the Fed’s plan to move rates higher, as they believe the current weakness is temporary. FOMC
members have also been “jawboning” to let the financial markets know they will likely move rates higher but in a
measured fashion in an effort to avoid another “taper tantrum” from 2013, which resulted in the 10 YR U.S. Treasury
yield climbing from 1.63% in May to over 3.0% at year-end. Fed Vice Chair Stanley Fischer recently said that monetary
policy in the U.S. will still be accommodative once tightening begins and that the pace of interest rate hikes will be datadriven.
Baird Fixed Income Research Analyst Craig Elder believes the most likely scenario at this time is a 25 basis point increase
at the September meeting followed by another 25 basis point move in December. He continues to express concern
about the ramifications on future interest rates when the Fed begins reducing the size of its $4+ trillion balance sheet,
especially if they sell securities along with the runoff of maturing securities to reduce the size of their holdings. Fixed
Income market participants would prefer that the Fed set monthly balance sheet reduction targets when they begin the
reduction, which we believe would take some of the volatility out of the market.
Highlighted below are recent events and municipal market activity. Action from the Fed will likely continue the rise in
interest rates.
Final Thoughts
Recent employment figures (a steady unemployment rate and non-farm payroll up 54,000 more than expected in May),
record municipal volume and the anticipation of a Fed rate increase have municipal rates on the rise as June gets
underway. As mentioned earlier, June’s traditional position as the strongest month in issuance might not be the case for
2015, as rate sensitivity will take refundings out of the market and new money issuance remains down 6% year-overyear at $55 billion. Stay tuned.
130%
Five-Year Historical 10-YR Ratio
125%
120%
115%
110%
May 29, 2015 Ratio,
103.30%
105%
100%
95%
90%
85%
Jun-11
Jul-11
Aug-11
Sep-11
Oct-11
Nov-11
Dec-11
Jan-12
Feb-12
Mar-12
Apr-12
May-12
Jun-12
Jul-12
Aug-12
Sep-12
Oct-12
Nov-12
Dec-12
Jan-13
Feb-13
Mar-13
Apr-13
May-13
Jun-13
Jul-13
Aug-13
Sep-13
Oct-13
Nov-13
Dec-13
Jan-14
Feb-14
Mar-14
Apr-14
May-14
Jun-14
Jul-14
Aug-14
Sep-14
Oct-14
Nov-14
Dec-14
Jan-15
Feb-15
Mar-15
Apr-15
May-15
80%
Baird Public Finance
COLUMBUS,
OHIO
614.629.6950
DENVER,
COLORADO
303.270.6330
NAPERVILLE,
ILLINOIS
630.778.9100
HOUSTON,
TEXAS
832.871.5291
PHILADELPHIA,
PENNSYLVANIA
610.594.7080
LANSING,
MICHIGAN
517.371.2483
ST. CHARLES,
ILLINOIS
630.584.4994
MILWAUKEE,
WISCONSIN
414.765.3827
TRAVERSE CITY,
MICHIGAN
800.793.6379
MAHTOMEDI,
MINNESOTA
612.499.3066
WINSTON-SALEM,
NORTH CAROLINA
336.631.5835
SOURCES: Department of U.S. Treasury Website; Thomson Reuters MMD; the Bond Buyer; Baird Fixed Income Commentary (Tom Wammack).
Note: Bond volume excludes short-term notes and private placements.
IMPORTANT DISCLOSURES
Baird may from time to time have a proprietary position in the debt obligations of the issuers mentioned in the report. This report is for information purposes only
and in no event should it be construed as a solicitation or offer to purchase or sell a security. The information presented herein is taken from sources believed to be
reliable, but we do not guarantee the accuracy or completeness. Any issue named or rates mentioned are used for illustrative purposes only and may not represent
specific features or securities available at a given time. The value of and income from investments may vary because of changes in interest rates, foreign exchange
rates, securities prices, market indexes, operational or financial conditions of the issuers, or other factors. Past performance is not a guarantee on future
performance. Preliminary Official Statements, Final Official Statements, or Prospectuses for new issues if mentioned herein are available upon request. For more
information regarding municipal securities, visit emma.msrb.org. This report does not provide recipients with information or advice that is sufficient on which to base
an investment decision. This report does not take into account the specific investment objectives, financial situation, or need of any particular client and may not be
suitable for all types of investors. Recipients should consider the contents of this report as a single factor in making an investment decision. Additional fundamental
and other analyses would be required to make an investment decision about any individual security identified in this report. For investment advice specific to your
situation, or for additional information, please contact your Robert W. Baird Financial Advisor and/or your tax or legal advisor.
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