Bond market commentary – week of March 30, 2020

The tug of war continues in the municipal market. The week of March 30, 2020 saw the MMD (Municipal Market Daily Index, put out by Thomson Reuters) increase by a range of 12 to 60 basis points, with the largest increases seen in the longest half of the yield curve. What happened?

• We came into the week with deals beginning to come to market again and data starting to point towards the market moving again.
• While redemption requests have not come near the peak experienced on March 19 ($4.5 billion), daily bid-wanteds still remain well above historical averages.
• This parlayed into the MMD seeing huge one day jumps, focus moving away from the primary market and deals struggling to be completed.
• Most deals were put on day-to-day status.

A heightened investor focus on credit quality emerged as a key underlying theme, with the current economic situation creating a lot of liquidity concerns for municipal issuers. With more states issuing stay at home orders, jobless claims doubling from the prior week and significant declines in utilization of public transportation infrastructure, investors have become increasingly concerned about the cash flow situation at the state and local levels. As a result, all rating agencies have come out with a negative outlook on the transportation and healthcare sectors, with S&P placing all U.S. Public Finance sectors on negative outlook.

The CARES Act set aside approximately $500 billion for the federal government to start buying municipal bonds, providing the market with much-needed liquidity. In simple terms, without this stimulus/liquidity from the federal government, there is not enough liquidity from market participants to support the high dollar amount of liquidation requests from bond mutual funds (they meet those redemption requests by selling bonds in their portfolio) and the $4-5 billion per week in new issuance. As a result, the new issuance market has been set aside.

The market requires clarity on how and when the stimulus dollars can start getting deployed and put to work by the Federal Reserve Bank. Once this clarity occurs, firms can start being more strategic in how they are going to deploy their capital and other market participants can start making decisions based on that deployment. The current level of uncertainty is so great that the market ceases to operate efficiently.

What is working in the favor of issuers? The answer to that is a lot:

• The muni-Treasury ratios are currently at levels that would support cross over buyers. In other words, institutions that normally don’t work in the municipal bond market are now involved,  because with the ratio of Treasuries to municipals, it makes more sense for them to purchase municipals
• The short-term market has continued to recover, with VRDB balances down 80% from the recent peak and SIFMA (the weekly short-term benchmark index) resetting Wednesday at 1.83% (down from 4.71% the prior week)
• The federal stimulus is a huge chunk of liquidity that should help stabilize, if not put downward pressure on, interest rates.
• The economy has come under much pressure with the worldwide slowdown, which should result in a flight to quality (leaving stocks and buying bonds), which would also put downward pressure on interest rates.

Through all this, it’s important to keep in mind that even with the current volatility in interest rates, we are at historically low interest rates.

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