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, recommend it is likely to be outright shrinking.
Buyers have poured report quantities of cash into muni funds, at the same time as a collection of occasions have conspired to maintain state and native authorities entities from issuing sufficient debt to fulfill traders. 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 informed MarketWatch.
To make certain, a few of the present skew is because of regular seasonal market patterns, stated Cooper Howard, director of fastened earnings technique for Charles Schwab. Muni bonds pay their coupons, or mature, leaving lots of money on the lookout for a house.
Thus far this yr, issuance has been comparatively secure. Via Could, state and native governments had issued about $188 billion of bonds, based on knowledge 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 may proceed.
“Bankers and consumers might each see much less exercise than wanted, the inflow of Federal money and surging state and native revenues minimize debtors’ wants for working capital,” wrote analysts at Municipal Market Analytics in a June 7 observe. “State and native governments, that are not yet showing a strong rebound in hiring, are additionally doubtless just a few quarters away from restarting conventional new cash infrastructure plans in earnest.”
That backdrop is, partially, what’s helped turbo-charge demand.
As beforehand reported, weekly cash flows into muni funds have smashed weekly records a number of instances this yr.
“The American Rescue Plan went a good distance to assist ease credit score issues,” Schwab’s Howard stated 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 sooner or later.
For now, these macro tailwinds are boosting demand past what may usually appear affordable. A closely-watched metric, the ratio of 10-year muni yields to these of comparable U.S. Treasurys
is about 60%, properly beneath the extra regular degree of 80%, and suggesting traders are paying fairly a bit extra for muni bonds than sovereigns.
“Buyers are merely ignoring how wealthy munis are proper now and cash retains pouring in,” Steeves stated.
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.
Giant funds are actually primarily compelled to purchase any deal that comes out, Steeves stated, leaving portfolio managers with little alternative to differentiate themselves from opponents, 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 more likely to wait and see whether or not they can maintain off on issuing extra debt.
What’s extra, whereas “municipal bond” is usually assumed to be synonymous with “tax-exempt,” issuers are more and more turning to taxable bonds as an alternative. Buyers are starved for any sort of paper, and there are fewer guidelines and laws round taxable issuances. Taxable debt made up 30% of muni issuance final yr, Howard stated, up from 10% traditionally.
“The muni market is shrinking,” Steeves stated.