Municipal market investors have enjoyed a long period of credit stability as bond issuing-states and local governments surfed the wave of post-pandemic federal stimulus. But that era has ended, and as the Trump administration continues to push down costs to the state and local level, credit concerns may become more important for buysiders, market participants said Thursday at the Bond Dealers of America conference in Chicago.
The end of federal support will also lay bare a widening gap between the market's haves and have-nots, panelists said.
"We've been in fairly benign credit environment in last few years, and that's allowed a lot of issuers to withstand volatility," said Triet Nguyen, vice president of strategic data operations at DPC Data. "That tailwind is about to go away," Nguyen said. "So we believe that fundamental credit concerns are about to come back as an essential component of your trading and management strategy."
The federal government allocated roughly $4.6 trillion under six pandemic laws passed in 2020 and 2021, including the prominent $350 billion State and Local Fiscal Recovery Funds, the key account for pandemic relief for cities, counties and states.
"Our market was then at $4 trillion," said one buyside panelist. "So do the math — that's way too much stimulus that came into the market."
The pandemic money "touched the state and local government sector the most," the investor said. Some states and cities "went on spending sprees, they didn't use it to cut back ... they got upgrades that didn't have a lot to do with fiscal management, they just got a federal windfall."
The difference in states' fiscal conditions can be seen in secondary market spreads, said another panelist. Illinois general obligation bonds have been trading at 62 basis points over the AAA scale and other states are at plus 45bps, the panelist said.
"So there really is a spread divide between the haves and the have nots," the panelist said. "There are real fiscal problems that [some states] are going to have to bridge when the spigot of fiscal stimulus stops ... We as bondholders need to hold certain states accountable."
The post-pandemic inflationary environment has led to higher prices across the board, marking another pressure point for local governments, said a banker. Many cities and towns may find themselves needing to spend more on social services at a time when the federal government is pulling back, they said.
Credit spreads are tight now but that won't last, said another buyside panelist.
"Portfolio managers and traders are more interested now in structure than credit," the investor said. But eventually "we're going to get back to wider spreads."
On the positive side, the pullback in federal funds will support new-money issuance in 2026 and beyond, said another panelist. Some federal stimulus fueled large capital plans and borrowing will now need to take up the slack, the buysider said.
