Taxable Fixed Income Markets

The third quarter of 2017 featured weak data, which brought into question the intentions of a seemingly dovish Federal Reserve. The Fed, while acknowledging some of this weakness, continues to see a strengthening economy and the likelihood of rising inflation. Chair Janet Yellen affirmed that the Fed may look to raise the Fed Funds rate again in December if the data supports it. All this should make for an interesting end to 2017.

MuniLand

Municipal bonds continued to garner strong demand through the quarter with positive fund flows. Interest rates on municipal debt moved lower through the quarter, hitting their low in early September before rebounding higher in the last week of the quarter. The tax-exempt status of municipal debt interest was not addressed in the first draft of the proposed tax reform bill and does not appear to be part of the debate on tax reform that will likely go on through the end of the year.

Puerto Rico and the U.S. Virgin Islands, both commonwealths of the United States and large issuers of municipal bonds, were hit hard by Hurricane Maria. Puerto Rico is currently in default and recovery levels in the 50-60% range were already optimistic in our view before Maria devastated the island. Puerto Rico appears to be in dire straits as 40% of the island continues to lack fresh water. We have never purchased any uninsured Puerto Rico bonds, and it looks like the fight to recover principal for existing bondholders could be bleak going forward.

From a valuation standpoint, municipal bonds seem to be somewhat expensive on average. However, better valuations exist in some pockets of the market, which is where our due diligence is focused now.