Bargain hunters are circling the $4tn US municipal bond market after a selling frenzy pushed the prices of some issues to record lows and prompted emergency intervention from the US Federal Reserve.
As the coronavirus crisis has spread fear through markets, investors have dumped all manner of assets in a desperate grab for cash. Typical havens such as the muni bond market, where US states and cities go to raise money, have not been immune.
Muni bond funds saw a record $12.2bn in withdrawals for the week ending March 18, according to data from Lipper. Yields on debt maturing in 10 years soared roughly 1 percentage point in a week, to 2.6 per cent. Yields rise when prices fall.
The selling pressure was so severe that the Fed stepped in last Friday, promising to expand a new money-market support facility to allow loans secured by munis. This marked quite a reversal for a market that had enjoyed extraordinary gains over the past year as investors sought to generate largely tax-free income from a corner of the debt markets that tends to produce few defaults.
Now, though, investors say they see opportunities in parts of the muni market that have been oversold. Highly rated bonds maturing in less than 10 years from large states are popular, portfolio managers said. The same is true for bonds issued by utilities and other organisations with solid revenue streams such as water-and-sewer systems. Investors have also taken a liking to bonds backed by settlements with tobacco companies.
“There are absolutely screaming values in the municipal space at this point provided one has the intestinal fortitude to ride out the volatility,” said Tom McLoughlin at UBS. “You are not reaching for yield any more. It is being offered to you.”
On Tuesday this week yields spiked above 7 per cent for Texas bonds maturing in August, according to data collected by the Municipal Securities Rulemaking Board. The bonds had not yielded more than 4 per cent until this month. And for the first time, yields on certain California bonds maturing in 2035 jumped above 4.5 per cent.
“Gutsy” investors who “can withstand volatility and who [are] not scared by extreme price action” are now putting cash to work, said Vikram Rai, head of municipal strategy at Citigroup.
Highly rated bonds from California and New York, in particular, have piqued investors’ interest, said Glenn McGowan, director of municipal underwriting at RBC Capital Markets. BlackRock was among the buyers of these securities in recent days.
“The muni market is arguably the cheapest of all when all is said and done,” said Rick Rieder, BlackRock’s chief investment officer of global fixed income, who oversees the group’s $2.3tn bond portfolio.
Dan Scholl, head of municipal fixed income at Wilmington Trust, said his firm has snapped up debt issued by Wisconsin, Pennsylvania and Maryland, as well as the city of Dallas.
“These are high-quality states that have significant cash reserves and the financial flexibility to withstand a decrease in revenue,” he said.
Because returns are largely tax-free, municipal bonds have historically yielded less than US Treasuries. But that dynamic has broken down as the coronavirus pandemic has shaken markets. Now that the benchmark 10-year Treasury note yields just 0.86 per cent, a new breed of buyers is jumping in to munis.
“While many mutual funds and trading accounts continue to face selling pressure, other money managers, banks, and insurance accounts have been buyers at these new yields,” Mr McGowan said.
Still, some muni debt investors are cautious given the unprecedented nature of the economic shocks associated with the viral outbreak. Many are concerned about the rising likelihood of defaults in the months ahead. Credit rating agencies have warned that city transit agencies from San Francisco to Washington will lose significant revenues due to coronavirus lockdowns, putting their ability to repay bonds in jeopardy.
Late last week Fitch downgraded about $2.2bn of debt issued by Suffolk county — an area just outside of New York City, which includes the upmarket Hamptons beaches — as the municipality cannot collect taxes with malls and restaurants closed.
“We’ve never gone through a full-stop in the economy so fast,” said Matt Buscone, co-head of portfolio management at Breckinridge Capital Advisors. “No one knows if this will be for 30, 60 or 90 days, or longer, so it is hard to determine a price if you don’t know what revenue will be.”
For Mr Rai of Citi, who believes the Fed should go a step further and include muni debt as part of its asset-purchase programme, volatility is likely to persist so long as Covid-19 spreads.
“As long as we keep getting news of the increasing number of infected people in the US, there will be pessimism about the overall financial sector in general,” he warned. “It will enhance the reticence on the part of investors to step in and put cash to work.”
Additional reporting by Jennifer Ablan