Asset Class: Municipal Fixed Income

President Trump’s infrastructure plan fails to ignite enthusiasm

Infrastructure plan

On February 12, 2018, President Donald Trump unveiled his $1.5 trillion infrastructure plan. The plan received an unenthusiastic response by all constituents as it does not meaningfully address this country’s ailing infrastructure.

With only $200 billion in federal funding, the plan forces infrastructure spending down to the state and local level with thoughts that private investment will fill the funding gap. The plan encourages the sale of federal assets and private management of federal infrastructure projects for cost savings. Additionally, to encourage greater private participation, President Trump is asking for a more streamlined approval permitting process. Upcoming midterm elections and an already pressured Congressional agenda will most likely prevent any passage of the proposed infrastructure plan in 2018.

The central goal of the plan is to alter the way infrastructure is built and maintained in the United States. The White House believes that historic overreliance on federal funding has created a disincentive for non-federal revenue sources. By providing seed money to state and local governments, the White House believes there will be a greater incentive for public-private enterprise. The President’s plan does provide an outline for ultimate legislation and marks a point from which negotiations with legislators can begin.

While many current federal infrastructure programs would remain in place, the plan would provide:

  • Competitive grants for state and local governments as well as expanded low cost federal loans.
  • Block grants encouraging rural infrastructure.
  • Funding to programs that encourage the incorporation of technological advancements.
  • Privatization of federal assets such as Ronald Reagan Washington National Airport, Washington Dulles International Airport and the George Washington Parkway.
  • A stream-lined approval process cut to two years or less via the appointment of a single federal agency charged with granting a single federal permit.
  • Expanded access to Private Activity Bonds (PABs), providing a financing mechanism for privately built assets via the tax-exempt debt market.

Ultimately, the primary obstacle to greater infrastructure spending is finding the money. This is the main reason the United States has suffered a long period of underinvestment in infrastructure. The nation’s reluctance to raise gas taxes, tolls and user fees will continue to hinder any infrastructure plan. Positively, President Trump has indicated that he would support an increase in the federal gas tax to help fund infrastructure programs. However, the recently passed federal tax plan limiting state and local tax deductions makes it more challenging to raise taxes and fees to fund the cost of infrastructure.

Already in to the third month of 2018, Texas Republican Senator John Cornyn has indicated that it is unlikely that there will be time this year to deal with infrastructure legislation given debates on the federal budget, guns, immigration, and the re-election campaigns.

In the end, the President’s plan simply is not bold enough to stir men’s blood.

 

muni 03 18 aaa yield curve graphMarket commentary

February saw a continuation of upward pressure on yields leading to a second month of negative returns in the muni market, albeit not as onerous as January. The Bloomberg Barclays 1-15 year Muni Blend Index declined 0.26% for the month, giving us a year-to-date decline of 1.13%. Not what we want to see as investors, but relatively mild compared to the volatility we have seen in the equity markets. The poor performance has had a negative impact on demand. Municipal funds and ETFs posted net outflows of $635 million in February, in stark contrast to the $10.5 billion that flowed into municipal funds in January. Outflows did ease towards the end of the month. We will see if another month of negative performance dampens investor interest going forward. We are going into the seasonally weak months of March and April for the municipal market. Municipal primary issuance typically picks up and selling pressures increase. But with supply significantly curtailed due to the lack of advanced refunding deals, it may be a mild spring for the municipal market.

With the 10-year Treasury yield bouncing in the 2.80-2.90% area, we seem to have found some stability for the time being. However, we face a variety of triggers for yields to move quickly in either direction — inflation, trade wars, equity volatility, European political changes, wage pressures, etc. U.S. employment continues to improve with a recent weekly initial jobless claims number of 210,000, the lowest in 49 years. As of this writing, a 25 basis point Federal Reserve hike to 1.75% is fully priced into the market. We will continue to follow the Federal Open Market Committee (FOMC) statements and member speeches closely for any forward looking guidance. We still expect pressure for yields to move higher, particularly on the short end of the curve, albeit, not as much as they have recently.

 

Strategy overview

Duration

We will continue to be shorter duration than our benchmark and peers.

Fixed income markets have been driven to higher yields by heightened concerns of inflation, potential for increased Treasury issuance and an active Fed. U.S. Treasury 10-year yields have risen 45 basis points year-to-date and 80 basis points from the low last September.

We are looking to invest some cash at these higher yields, but supply is very thin.

Curve

Overweight municipal floating-rate notes. Avoiding fixed-coupon bonds on the shorter end of the yield curve due to expected Fed rate hikes. Continue to monitor inflation and expectations. Fed has indicated more confidence in attaining their 2% target this year.

Daily and weekly tax-free, floating-rate-note yields have retreated from the spike higher we saw at the end of 2017, but still attractive versus a year ago. The weekly municipal floating rate index (SIFMA rate) is at 1.09% (2/28/2018) versus 0.62% on 3/1/2017.

Credit and structure

Like January, not much difference in the performance of lower and higher quality bonds with the Bloomberg AAA and BBB indices down about 30 basis points for the month. Municipal high yield was able to eke out a positive 7 basis points of return for the month. Bonds rated BBB continue to offer little additional spread over higher quality bonds on an historical basis.

Sector

We like prepaid gas bonds at this time. These somewhat unique tax-exempt bonds can be issued as floating-rate notes with credit support from financial institutions. These institutions are in strong capital positions and benefit from rising interest rates.

The Bloomberg Illinois Index did underperform by about 15 basis points over the month; however, it has outperformed the broader index by 175 basis points over the past year.

 

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