Municipal Market Update
 

June 2009

By Gary Gildersleeve

Partner & Fixed Income Portfolio Manager

Municipal bonds have significantly outperformed U S Treasury bonds thus far in 2009.

Municipal bonds have significantly outperformed U S Treasury bonds thus far in 2009. Concerns about reduced tax exempt supply (especially on the long end resulting from the successful issuance of Build America Bonds), expectations for higher Federal and state income tax rates, anemic cash yields, and a steep yield curve collectively led to lower yields for municipal bonds across the maturity spectrum (see Muni AAA yields). At the same time, Treasury yields were increasing due to the unwinding of the "flight to quality" trade, early signs of an economic recovery which contributed to a shift to equities, a steady stream of Treasury supply and international fears that financing of the multi-trillion dollar Federal budget deficit would require higher yields. As a result, the municipal/Treasury yield ratios for maturities 5 years and longer have returned to more historically "normal" levels (see Muni/Treasury ratios).

Significant amounts of cash remains on the sidelines earning paltry returns and will likely be exacerbated by the considerable demand expected in the June-August reinvestment period (as a result of maturities, calls, and coupon payments). Nevertheless, volatility, inconsistent liquidity, and greater credit yield spreads have returned to the municipal market, which is facing formidable new issue supply. Further, the State of California's budget plight, which is unique only in its extreme, highlights the difficulties most states are continuing to encounter and may be a harbinger of more negative credit news still to come from the general obligations of many states and municipalities.

The increase in municipal yields since Memorial Day combined with reinvestment demand mentioned earlier should lead to relatively good performance by tax exempts in the near term, provided the domestic equity market doesn't surge to new 2009 highs and the 10year Treasury yield remains near present levels. We are continuing to emphasize independently researched upper investment grade essential purpose and dedicated tax issues with stable revenue streams to pick up additional yield, while shunning most general obligations (and their accompanying difficulties in raising and/or maintaining their tax receipts). High coupon issues priced to a call (which are refunding candidates) will continue to receive special attention.

Gary Gildersleeve joined Evercore Wealth Management as a founding partner in 2008 with over 33 years of experience in managing fixed income investment strategies for high-networth individuals.

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