WEALTH SOLUTIONS GROUP

Muni Fortnightly

Treasury curve bear-flattens on tax policy

advancement and Flynn plea. Munis generally David N Violette, CFA
Senior Fixed Income Analyst
underperform.

December 4, 2017

Bottom Line:
Treasury yields were volatile on tax plan progress and the Friday-Flynn-Flattener. On the week,
yields bear-flattened.
Munis had the worst month in a year as a rush to issuance before new tax policy may roll back
benefits to issuers. The 10yr AAA GO Ratio stabilized after a brisk move higher.
Moodys Q3 upgrades outnumbered downgrades but notional downgrades exceeded upgrades.
Moodys sector outlooks include Stable outlooks for community colleges, toll roads and positive for
airports.
S&P Puerto Rico Total Return Index was -0.7% two weeks; -17.4% YTD.

What Happened in the Bond Markets Last Week?

Treasury yields ended slightly higher and the curve continued to flatten as domestic and global equities ripped
through more milestones. Yields were driven by two domestic things. 1) The expectation and eventuality of
the Senate tax overhaul plan. This had the effect of lifting risky assets along with shorter and belly yields. 2) A
sizeable rally and flattening hit the curve on Friday on the Flynn admission to guilt and plea bargain. However,
yields came off their lowest levels on Friday. The componentry of the yield changes were for an offsetting rise
in real-yields and offsetting declines of inflation breakevens on the front end of the curve and higher
breakevens on the long-end the inflation breakeven curve effectively steepened. Bitcoin was not a third
thing that happened to Treasuries.
Municipal yields underperformed Treasuries again. As was mentioned a few weeks ago, the municipal market
is still trying to digest the probability and magnitude of tax changes on the municipal market and is currently
digesting a late-year rush of municipal bond sales.

Yields (Figure 1):

For the week ending 12/1/17 Treasury yields traded higher and flatter; 2-year Treasury Note yields were +3.0
bps to 1.77%, 5-year Notes yields were +5.4 bps at 2.12%, 10-year Notes yields were +2.3 bps to 2.37% and
30-year bonds yields were flat bps at 2.76%.

Bloomberg Municipal Index curve yields were mostly higher and the curve flatter, AAA-rated GO yields; 2-
year bonds were +19 bps to 1.50%, 5-year bond yields were +9 bps to 1.73%, 10-year bond yields were +4
bps bps to 2.14% and 30-year bonds were -7 bps to 2.76%.

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The Ratio of 10-year AAA GO debt to 10-year Treasury yields rose off week-ago levels to 90.9 from 90.0 last
week. The year-to-date average is 89.3 and the 12-month average is 90.0.
.
Figure 1 - Yield Curve and Muni Curve Changes Data Source: Bloomberg

One can observe these changes by looking at how rates have changed along the curve for both the Treasury curve
and for the AAA-rated G.O. Index since last week. The top panel shows four yield curves; two for the Treasury curve
(in red) - one for the most current date and one from last week and two for the AAA-rated G.O. (in blue) - current and
last week. The bottom panel of the graph shows changes in the rates along both curves for the week for both
Treasuries and the AAA G.O. Index.

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Figure 2 - Muni Ratio Data Source: Bloomberg

AAA 10-Year G.O. Muni Ratio to Treasury

110.0

105.0

100.0
Ratio (%)

95.0

90.0
90.9
85.0

80.0

Mid Price SMAVG (50)

Supply (Figure 3) Bloomberg 30-Day Visible Supply currently stands at $26.0 billion up from $22.3 billion this time
last week. The YTD average visible supply is $11.6 billion and the 12-mo average is $11.5 billion. This weeks expected
volume exceeds the entire volume of last December.

Figure 3- Bloomberg 30-Day Visible Supply - 1 Year; Data Source: Bloomberg

Bloomberg 30-Day Visible Supply
U.S. Total

35,000

30,000

25,000
$ Million

20,000

15,000

10,000

5,000

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Articles of Interest
Municipal Fund Flows: According to Lipper data muni funds had net inflows of $100.4 million after $659.2 million of net
inflows during the previous week. The four-week moving average was $410.1 million of inflows. High-yield funds had net
inflows.
Moodys Q3 Ratings: During Q3 2017 Moodys rating revisions resulted in upgrades outnumbering downgrades (122
to 104) reversing the previous quarters performance. The notional dollar amount downgraded was greater than that
upgraded ($28.2 B to $23.5B) with the biggest downgrades in PREPA (to Ca) and the Commonwealth of Kentucky (to
Aa3). The largest upgrade was for the State of Wisconsin (to Aa1). Pension funding was a contributor to both KYs and
WIs rating changes.
Moodys 2018 Sector Outlooks:
Airports: Moodys has a positive outlook for the airport sector. Some highlights of their outlook: 1) Moodys
expects economic growth to result in 3.7% enplanement growth. They expect smaller airports to have the
strongest enplanement growth 2) Moodys expects seat capacity to grow between 4.5% and 5.7% in 2018. 3)
Airport parking-related revenues will be kept in check by passengers turning to services such as Uber and
Lyft.
Toll-roads: Moodys has a stable outlook for the government-owned toll road sector. Some highlights of
their outlook: 1) Moodys expects 2-3% traffic growth for toll roads in 2018. 2) They expect too rate increases
particularly those that are indexed to inflation to support revenue gains of 3-4%. 3) Economic growth and
stable gas prices will support growth in traffic (1.7% growth in 2017). 4) Start-up roads in urban areas (Austin,
Atlanta, and Orlando) will experience greatest growth.
Community colleges: Moodys has a stable outlook for community colleges that issue revenue-backed
debt. The highlights of their outlook: 1) Modest revenue growth of 1.5-2.5% on stabilization of aggregate
enrollment, after declining for several years. Tuition increases will help stabilize revenues also. 2) Growth in
local tax revenues and level state funding will support revenues. 3) Expense flexibility in labor and facilities
remain a sector strength.
Puerto Rico:
o The federal oversight board (PROMESA) is set to meet this week to begin a revised fiscal plan by the end of
the year.
o The University of Puerto Rico reportedly made its interest payment last week, avoiding default as of now. The
university would like to restructure its debt by extending maturities, suspend and reduce debt-service
payments.
o The S&P Municipal Bond Puerto Rico Index finished at 145.9 on Friday vs. 147.0 at the end of two weeks
ago, -0.7%%. Year-to-date the index is -17.4%.

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S&P Municipal Bond Puerto Rico Index Level (1-year)

Relative Value by Maturity

Table 1 - AAA Muni Ratios and Spreads by Maturity - Data Source: Bloomberg
12/4/2017 Yield-to-worst (%) 0% Tax Rate 35% Tax Equivalent
Maturity (yrs.) AAA Gen. Oblig. Treasury Spread (bps) Ratio (%) Spread (bps) Ratio (%)
1 1.30 1.62 -31.3 80.6 38.9 124.0
2 1.50 1.80 -30.1 83.3 50.7 128.1
3 1.58 1.92 -34.3 82.1 50.6 126.4
4 1.64 2.07 -43.4 79.0 44.7 121.6
5 1.74 2.15 -41.1 80.9 52.4 124.4
7 1.91 2.30 -39.0 83.1 64.0 127.8
10 2.15 2.40 -24.7 89.7 90.9 138.0
15 2.47 2.45 1.9 100.8 134.6 155.0
20 2.63 2.57 5.6 102.2 147.0 157.2
25 2.71 2.68 2.8 101.0 148.5 155.4
30 2.76 2.79 -2.6 99.1 146.2 152.4

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Figure 4 AAA General Obligation Ratios and Spreads Data Source: Bloomberg

AAA G.O. Muni Ratio and Spreads

(0% Tax Convention)
105.00 10.0
100.00
0.0
95.00

Spread (bps)
90.00 -10.0
Ratio %

85.00
-20.0
80.00
75.00 -30.0
70.00
-40.0
65.00
60.00 -50.0
1 3 5 10 20 30
Maturity (yrs.)

Ratio (%) (Left) Spread (bps) Right

Relative Value by Rating

Figure 5 Muni Index Yield Curve by Credit Rating Data Source: Bloomberg

4.00
Muni Yields by Rating
3.50

3.00

2.50
Yield (%)

2.00

1.50

1.00

0.50

0.00
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30

Treasury AAA AA A

For more information please contact your Financial Advisor.

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Appendix Important Disclosures

Some of the potential risks associated with fixed income investments include call risk, reinvestment risk, default risk and
inflation risk. Additionally, it is important that an investor is familiar with the inverse relationship between a bonds price
and its yield. Bond prices will fall as interest rates rise and vice versa.
When considering a potential investment, investors should compare the credit qualities of available bond issues before
they invest. The two most recognized rating agencies that assign credit ratings to bond issuers are Moody's Investors
Service (Moodys) and Standard & Poor's Corporation (S&P). Moodys lowest investment-grade rating for a bond is
Baa3 and S&Ps lowest investment-grade rating for a bond is BBB-. Ratings are measured on a scale that ranges from
AAA or Aaa (highest) to D or C (lowest).
The Bond Buyer 20-Bond Index consists of 20 general obligation bonds that mature in 20 years. The average rating of
the 20 bonds is roughly equivalent to Moody's Investors Service's Aa2 rating and Standard & Poor's Corp.'s AA. The
Bond Buyer 11-Bond Index uses a select group of 11 bonds in the 20-Bond Index. The average rating of the 11 bonds is
roughly equivalent to Moody's Aa1 and S&P's AA-plus. The Bond Buyer Revenue Bond Index consists of 25 various
revenue bonds that mature in 30 years. The average rating is roughly equivalent to Moody's A1 and S&P's A-plus. The
indexes represent theoretical yields rather than actual price or yield quotations. Municipal bond traders are asked to
estimate what a current-coupon bond for each issuer in the indexes would yield if the bond was sold at par value. The
indexes are simple averages of the average estimated yields of the bonds, are unmanaged and a direct investment
cannot be made in them.
This is not a complete analysis of every material fact regarding any sector, municipality or security. The opinions
expressed here reflect our judgment at this date and are subject to change. The information has been obtained from
sources we consider to be reliable, but we cannot guarantee the accuracy. Municipal securities investments are not
appropriate for all investors, especially those taxed at lower rates. The alternative minimum tax (AMT) may be
applicable, even for securities identified as tax-exempt. It is strongly recommended that an investor discuss with their
financial professional all materially important information such as risks, ratings and tax implications prior to making an
investment. Past performance is not a guarantee of future results.
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.
ADDITIONAL INFORMATION ON SECURITIES MENTIONED HEREIN IS AVAILABLE UPON REQUEST BY
CONTACTING YOUR BAIRD INVESTMENT PROFESSIONAL.
Copyright 2017 Robert W. Baird & Co. Incorporated.

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