With a first-quarter total return of 2.90%, the municipal bond market – as measured by the Bloomberg Barclays Municipal Index – is off to its best start since 2014.1 Since the start of the 21st century, the first quarter has been stronger only in 2000, 2009, and 2014, and the 2000 performance topped this quarter’s performance by just 2 basis points (0.02 percentage points).
This year’s start is even more impressive given the developments in the U.S. Treasury market. Late in the first quarter, the 10-year Treasury hit a 15-year low of 2.34%, and the Treasury yield curve inverted.2 When the rate on a 3-month Treasury bill exceeded the rate on the 10-year Treasury bond, the “r” word reared its ugly head. As OppenheimerFunds’ Brian Levitt recently explained, not all yield curve inversions portend a recession: “Recessions tend to be preceded by the Federal Open Market Committee raising the Fed Funds rate above the 10-year Treasury Rate, and not by the 10-year rate falling below the Fed Funds rate after the Fed has already completed its tightening cycle.”
Additionally, the Federal Open Market Committee (FOMC) signaled late in the quarter that it does not intend to raise the Fed Funds rate, which it controls, in 2019. The rate, which was raised in December 2018 to the range of 2.25% to 2.50%, had been raised nine consecutive times, including four times in 2018. In the fourth quarter of 2018, investors may recall, the FOMC surprised the markets with its announcement that 2019 would likely see two or fewer rate increases. By the end of the first quarter of 2019, the plan had shifted, and Fed chairman Jay Powell said that “my colleagues and I will be patient in assessing what, if any, changes in the stance of policy may be needed.”
Investors’ concerns about the future of interest rates, meanwhile, created increased demand for Treasuries and municipal bonds alike, and yields continued to fall at all maturities. In the muni market, AAA-rated bonds with maturities of 3 years or less experienced the smallest yield decreases. The AAA-rated muni curve continued to flatten during the quarter, and the yield difference between 1-year and 30-year bonds was just 112 basis points (bps). The Treasury yield curve, meanwhile, grew slightly steeper.
Strengthened by flows, technicals in the muni market remained strong throughout the quarter, and demand continued to exceed supply. For the first quarter of 2019, volume for bonds maturing in more than one year totaled $75.0 billion, up 14.6% versus the first quarter of 2018; bear in mind that first-quarter volume in 2018 was sharply depressed relative to the first-quarter volume in prior years because the Tax Cuts and Jobs Act (TCJA) of 2017 led many municipalities to come to market late in 2017 with bonds that were originally slated for the early months of 2018.
Municipal bond funds that tend to invest across the credit spectrum – as ours do – continued to benefit from credit spread tightening. As was the case in much of 2018, tightening created strong demand for below-investment-grade securities, and yields and returns for these bonds remained quite attractive in the three months ended March 31, 2019.
Bonds issued by Puerto Rico underperformed the first-quarter market by 85 basis points, but they continued to be additive to the performance of the funds that held them.3 Both the overall and high-yield indices of Puerto Rico bonds outperformed the overall market for the 12 months ended March 31, 2019.
While news continued on many fronts during the first quarter, two big stories dominated. Early in February, Judge Laura Taylor Swain approved the structure of the COFINA plan of adjustment, and prices of these sales-tax-revenue bonds rose handsomely. The restructuring affects $17.6 billion in securities, the largest class of Puerto Rico debt, and the new COFINAS have implied yields of 5.6% to 5.8%. The settlement agreement specifies that the recoveries will be 93% for COFINA seniors and 56.4% for COFINA subordinate bonds. Of paramount importance to shareholders is that the income stream has been turned on again, after nearly 2 years on our non-accrual list.
Also in February, a federal appellate court ruled that the initial selection process for members of the Oversight Board (established by PROMESA) was unconstitutional. The board was told that its prior decisions will stand and that it could continue to function for 90 days. This ruling served to escalate the disputes that have ensued since PROMESA became law.
The Rochester investment team manages 13 municipal bond funds, 6 of which are available to all U.S. investors seeking tax-free income. In an effort to meet the diverse financial objectives of fixed-income investors, we offer funds that adhere to the same investment philosophy – we call it the Rochester Way – but have very different parameters and risk profiles.
Oppenheimer Short Term Municipal Fund (ORSTX), for example, may not invest in territory bonds, seeks an average effective maturity (AEM) of 2 years or less, and may invest 5% of its total assets in below-investment-grade bonds and another 5% in non-rated bonds. At the other end of our fund spectrum is Oppenheimer Rochester High Yield Municipal (ORNAX), which has neither a maturity cap nor a limit on below-investment-grade holdings.4
Investors should note that after Invesco’s acquisition of OppenheimerFunds has been finalized – it is currently slated for late May – all fund names will be preceded by the word Invesco. Importantly, we have been told that there will be no significant changes to the Rochester team, location, process, or investment style at close, and that ticker symbols will remain as is.
Both companies have a reputation for high-conviction investing, which we see as another reason for current and prospective investors to celebrate.
- ^The index consists of a broad range of investment-grade municipal bonds, is unmanaged, and cannot be purchased. Our funds’ investments are not limited to the investments comprising the index. The performance of the index includes reinvestment of income but does not reflect transaction costs, fees, expenses, or taxes.
- ^Treasury bonds are backed by the full faith and credit of the U.S. government.
- ^Oppenheimer Short Term Municipal Fund, Oppenheimer Intermediate Term Municipal Fund, and Oppenheimer Municipal Fund cannot invest in the securities issued by Puerto Rico or other U.S. territories.
- ^Investors should note that ORNAX typically invests between 50% and 70% of assets in high-yield bonds.
Fixed income investing can entail credit and interest rate risks; as interest rates rise, bond prices generally fall and a fund’s share price can fall, too. A portion of a municipal bond fund’s distributions may be subject to tax and may increase taxes for investors subject to federal alternative minimum tax. Capital gains distributions are taxable as capital gains.
Below-investment-grade (“high yield” or “junk”) bonds are more at risk of default and are subject to liquidity risk. Under certain market conditions, some unrated securities may trade less actively than rated securities. Our funds can have a relatively high portion of their portfolio holdings in particular segments of the municipal securities market, such as tobacco bonds or real-estate-related securities. They may also invest substantially in municipal securities within a single state or related to similar type projects, which can increase volatility and exposure to regional issues. Funds may also invest substantially in Puerto Rico and other U.S. territories and possessions, and could be exposed to their local political and economic conditions.