Municipal bond market spreads and pricing are increasingly influenced by the use of data mining and sophisticated data-driven models. What do fixed income market participants need to know about the role of automation and other trends in 2020?
- Automation is increasingly being used to identify relative value for municipal bonds, based on real-time trade data and/or historical spreads.
- Data-driven models can identify and normalize credit spreads, run regressions, and apply credit curves to outstanding bonds with comparable credit quality.
- In other municipal bond market trends, demand for taxable muni bonds should continue to benefit from foreign investors seeking high quality assets and diversification.
As the pricing vendor for many municipal bond funds and wealth management platforms, Refinitiv is well placed to highlight the key trends in the municipal bond market in 2020.
Our extensive pricing data on more than one million municipal bonds offers the breadth, quality, and reliability required by all fixed income market participants.
Many of the municipal bond market themes we are seeing involve the increased use of data mining and automation, and their potential impact on spreads, and therefore, prices.
Taxable municipal bond issuance
Last year, we witnessed a surge in taxable municipal debt relative to tax-exempt debt.
Issuance of taxable bonds totaled US$70 billion in 2019, increasing 135 percent over the prior year.
As part of the 2018 tax reform legislation passed by U.S. Congress, municipalities were prohibited from tax-exempt advance refunding, but could refinance the debt with taxable municipal bonds.
With rates at historically low levels, and demand from a broader investment base that includes foreign investors seeking high-quality assets and increased portfolio diversification, the demand for taxable municipal bonds should continue in the foreseeable future.
High-yield municipal bonds
Entering a record 11th consecutive year of economic growth, the continuation of the current expansion is front-and-center on investors’ minds.
Despite the uncertain outlook, fund flows into municipal bonds, particularly into high-yield debt remains robust. This is driving the yield penalty borrowers pay for additional credit risk to near all-time lows.
It remains to be seen if municipal credit fundamentals are as resilient as current yields suggest.
Investors will be watching closely whether a hiccup in the growth trajectory or changes in the political landscape trigger a reassessment of credit risk.
As we have seen in the past when investors no longer reached for alpha by chasing high-yield bonds, outflows increased, and spreads have typically widened.
The rise of data-driven models
As a data provider to many municipal bond investors and risk managers, we have seen the increased use of automation to identify relative value for municipal bonds based on real-time trade data and/or historical spreads.
Pricing models source trade data and market color as direct observations to price more liquid securities.
More sophisticated models can build databases of trade data, identify and normalize credit spreads, run regressions to build credit curves, and apply these curves to outstanding bonds with comparable credit quality.
Yet it is important to have a rigorous quality control process to cleanse data inputs and review outputs on behalf of customers.
As the use of technology increases, more liquid securities will have greater price transparency for both taxable and tax-exempt municipal bonds.
For less liquid securities at the lower end of the credit curve, fundamental credit analysis will continue to be necessary as technical factors change, impacting spreads and prices.