The U.S. municipal bond market is thought for being many issues: staid, stuffy, well-suited to capital preservation, if not growthy alternative. However now, lopsided metrics of provide and demand, with no aid in sight, counsel it is perhaps outright shrinking.
Traders have poured file quantities of cash into muni funds, at the same time as a sequence of occasions have conspired to maintain state and native authorities entities from issuing sufficient debt to fulfill buyers. Some corners of the market are so tight that funds are turning cash away, famous Brian Steeves, portfolio supervisor for Rye Brook, New York-based Belle Haven Investments.
“It’s a meals combat,” Steeves advised MarketWatch.
To make certain, a few of the present skew is because of regular seasonal market patterns, mentioned Cooper Howard, director of mounted earnings technique for Charles Schwab. Muni bonds pay their coupons, or mature, leaving masses of cash in search of a house.
To date this yr, issuance has been comparatively steady. By way of Might, state and native governments had issued about $188 billion of bonds, in keeping with information from the Municipal Securities Rulemaking Board, in comparison with $152 billion throughout the identical interval in 2019.
However many analysts query whether or not that can proceed.
“Bankers and consumers could each see much less exercise than wanted, the inflow of Federal money and surging state and native revenues reduce debtors’ wants for working capital,” wrote analysts at Municipal Market Analytics in a June 7 be aware. “State and native governments, that are not yet showing a strong rebound in hiring, are additionally probably just a few quarters away from restarting conventional new cash infrastructure plans in earnest.”
That backdrop is, partly, what’s helped turbo-charge demand.
As beforehand reported, weekly cash flows into muni funds have smashed weekly records a number of occasions this yr.
“The American Rescue Plan went a great distance to assist ease credit score issues,” Schwab’s Howard mentioned in an interview. Ongoing financial re-openings and state and native budgets coming in less-bad than many had feared additionally helps, as do investor issues that their earnings taxes may rise in some unspecified time in the future.
For now, these macro tailwinds are boosting demand past what may usually appear cheap. A closely-watched metric, the ratio of 10-year muni yields to these of comparable U.S. Treasurys
is about 60%, effectively under the extra regular degree of 80%, and suggesting buyers are paying fairly a bit extra for muni bonds than sovereigns.
“Traders are merely ignoring how wealthy munis are proper now and cash retains pouring in,” Steeves mentioned.
That signifies that in a single part of the market, for high-yield munis, “there’s simply not sufficient offers.” That was the conundrum dealing with the Invesco Excessive Yield Municipal Fund, which announced in May that it would close to new investors.
Massive funds at the moment are primarily compelled to purchase any deal that comes out, Steeves mentioned, leaving portfolio managers with little alternative to tell apart themselves from rivals, and leading to zero worth discovery in that portion of the market.
Maybe much more unsettling is the notion that issues may worsen from right here. With the potential for even more money earmarked for infrastructure spending coming from Washington, native governments are prone to wait and see whether or not they can maintain off on issuing extra debt.
What’s extra, whereas “municipal bond” is commonly assumed to be synonymous with “tax-exempt,” issuers are more and more turning to taxable bonds as an alternative. Traders are starved for any type of paper, and there are fewer guidelines and laws round taxable issuances. Taxable debt made up 30% of muni issuance final yr, Howard mentioned, up from 10% traditionally.
“The muni market is shrinking,” Steeves mentioned.