The National Perspective
Over the course of 2014, a number of economic and policy variables are likely to impact the municipal bond market. Consensus expectations of the Federal Reserve indicate a gradual tapering of the Fed’s asset purchase program. While the initial market response may be negative, over time more attractive valuations may draw buyers to the market. The long end of the yield curve has flattened while we’ve seen a steepening on the short end. Estimates of the 2014 year-end yield on the 10-year Treasury fall near 3.50%. Municipal bonds remain attractive relative to Treasuries. In this environment, the bond markets could produce low, but positive, total returns for the year.
A number of near-term events could generate volatility in the bond market. During the first quarter, Washington will be required to address the debt ceiling and the Federal budget. In the recent past, these debates, along with the scenario of a disaster narrowly averted, have created inflection points in the bond markets which provided attractive valuations. Although tax reform proposals may emerge this year, it seems unlikely that legislation will be enacted, particularly with legislators focused on mid-term elections. Headline risk is likely to remain a factor in connection with Detroit, Illinois, Puerto Rico and the pension liabilities of individual municipal credits.
At the same time, there are significant positive factors influencing the municipal market. The financial condition of most municipalities has improved with modest economic growth and a corresponding increase in revenues. State tax collections have been growing for over 3 years now, while defaults are occurring at the slowest pace since 2008. Valuations have become attractive and declining new issuance is supporting those valuations to some degree. With the on-set of tax season, as the impact of recent tax changes becomes clear, interest in tax-exempt municipal income is likely to rise. Should rates rise, the municipal tax-exemption becomes even more attractive.
We believe that municipal bonds could outperform other fixed income categories in 2014. In the second half of 2013 the yield on a typical “A” rated municipal bond was at least as much as an equivalent “A” rated corporate bond. This enticed investors seeking total return to buy municipal bonds, even when they did not need the tax advantages of municipal bonds. Another year of anticipated lower municipal bond issuance (reduced supply) and higher tax rates (heightened demand) could make municipal bonds more attractive in 2014.
The Local Perspective: Utah
Municipal issuance for the state of Utah in 2013 was about 31% lower than the issuance in 2012. We expect that 2014 new money issuance in Utah will be about 20% lower than in 2013. Advanced refunding of municipal debt is expected to slow as rising interest rates and continued low escrow reinvestment rates will make it difficult for issuers to receive significant savings in debt service payments.
In 2014 we anticipate more issuance from Charter Schools. This sector carries the moral obligation of the State of Utah and a Standard & Poor’s rating of AA. There have been only 3 bonds issued under the Charter School program since 2012. Because this is a fairly new program, few investors understand the credit characteristics, resulting in yields that have been very attractive to investors. We expect to continue to participate in this program while advantageous yields are available.
We have seen an increase in the issuance of assessment bonds in Utah in 2013, and this trend is likely to continue in 2014. Most assessment bonds are for roads and utilities on raw land that is to be developed. After the real estate market collapsed in 2008, issuance of assessment bonds fell off dramatically. Among the reasons for the lack of issuance was reduced demand for housing and the number of assessment bonds that were in default. Aquila Tax Free Fund For Utah may invest in assessment bonds when we believe there is a clear ability on the part of the developers to pay the assessments.
Before investing in a Fund, carefully read about and consider the investment objectives, risks, charges, expenses, and other information found in the Fund prospectus. The prospectus is available from your financial advisor and when you call 800-437-1020 or visit www.aquilafunds.com.