Despite Fed cut, global markets roiled; short-end munis face pressure as investors seek cash
Even after the Fed cut rates to near zero, the stock market plunged Monday, setting off automatic circuit breakers that shut down trading. Short-end munis were being blown out with yields rising as much as 20 basis points on the short end as investors seek cash.
The globe is facing a pandemic that is testing what financial markets, governments, and individuals can reasonably handle.
The municipal finance industry is dealing with minute-by-minute news of state-wide school closures, shuttered restaurants, curfews and canceled events. New issues are increasingly being put on the day-to-day calendar.
Governments are trying to assess the financial impacts on their budgets and planning how they deal with the very real lost revenues from this virus. New York City noted that it will likely see a $3.2 billion decline in less revenue over the next six months.
Municipal market participants note that it’s hard to evaluate what is transpiring in the larger world economy in simply a muni vacuum.
“Think of the psychology that is operational. The shelves in the stores are almost empty of the basics we all need. It is essentially preparing for Armageddon. It is different from preparing for the nuclear winter,” said John Hallacy, contributing editor at The Bond Buyer. “In much the same way, there is a basic instinct to value cash the most at times like this. That instinct makes folks want to liquidate their holdings and to keep the cash at the ready. It is usually not the ideal long-term strategy. The losses are locked in, but you have the cash to get by."
"Fortunately, not all are doing so. But I think this is the driver for widening the spread dramatically in the last couple of days," Hallacy said. "Buying will be steady but will pick up more when there is evidence that the virus is abating even if for an unknown period." He added that, for issuers, rates are still historically attractive.
Before the coronavirus hit hard there was plenty of cash on hand with much of it sitting on the sidelines around the globe. Muni inflows were staggering and muni supply was paltry compared to the demand investors were seeking. Triple-A, double-A, junk — it was all flying off the shelves.
“This has been such an amazing year,” Vikram Rai, head of municipal strategy at Citigroup, said in a Monday morning conference call. “We started the year looking for higher yields. And things have changed very quickly — we wanted higher yields, but not at this expense.”
Rai said the Fed moved very quickly to combat the effects of the COVID-19 spread and that its actions will aid liquidity in the muni market, but he was unsure if it would help stem market panic.
“I think it will help, but monetary stimulus will not be enough,” he said, adding that the markets were also looking for fiscal stimulus from the federal government as well as a coherent healthcare response.
The size of the QE program exceeded expectations, “but many investors remain worried and many economists are cutting U.S. second quarter GDP numbers deeply into negative territory,” said John Vail, chief global strategist at Nikko Asset Management. “It is quite possible that the Fed will need to find a way to buy risk assets like equities and corporate bonds, like most other major central banks do in some form or another, in order to stabilize market expectations. Negative interest rates would likely be counter-productive, so they will likely skip that step.”
“It’s hard to get a handle on the markets right now from a high level, but it seems the markets are correlated in one direction, which in my opinion points to another liquidity event. I think the actions of the Fed confirms this,” said Frank Dos Santos, managing director of pricing, valuations, and reference data at IHS Markit.
Meanwhile, many more deals again this week are moving to the day-to-day calendar, with the state of Washington’s $350 million of various purpose general obligation refunding bonds and MVFT GO refunding bonds were taken off the calendar. Also placed on the day-to-day calendar was the Franklin County Convention Facilities Authority's $136 million of taxable tax and lease revenue anticipation refunding bonds.
“If issues and structures are flexible, that should go a long way in completing transactions,” said Tom Kozlik, head of municipal strategy and credit at Hilltop Securities. “However, it is difficult to know exactly what could happen — positively or negatively — as a result of market sentiment.”
“Breaking news about health conditions, potential monetary or fiscal policy, or investor activity could continue to shift the markets gingerly or force them to react sharply,” Kozlik said. “As a result, there could continue to be opportunities for savvy municipal investors to take advantage of blanket or forced selling by funds due to larger than expected fund withdrawals.”
“It is hard to guess how much of [the estimated supply] will actually come to market given the current market volatility,” said Patrick Luby, senior municipal strategist at CreditSights. “The taxable calendar for this week totals $3.8 billion but last week's actual issuance of $850 million was less than half of the $3.0 billion that was expected, so interested investors should not be surprised by deals getting moved to later dates,” Luby said.
The absence of new-issuance amid volatility and instability is making for light volume and muted activity in the municipal market Monday, a New York trader said.
“I think there’s some trading going on, but at adjusted levels,” he said. “Volume is pretty light, and people are just trying to find their footing right now.”
He said with new issues largely postponed that issuers are interested in selling bonds and taking advantage of the low rate climate.
“I think right now a day or two with some stability and without customer bid lists and establishing a benchmark would start putting deals in the market.”
He said although there have been markets with a day or two of volatility in the last 10 years, he hasn’t seen prolonged volatility since the 2008 financial crisis.
“To have it sustained like this, I haven’t seen it like this in a while,” he said.
“Everybody is hunkering down and it’s hard to say specifically what investors are doing,” he added. “Everyone is trying to do business as usual as much as they can, but most people are in a day-to-day mode. We will need some stability before that happens.”
The virus continues to create volatility and uncertainty in the markets.
“A coronavirus driven market created unprecedented volatility and created chaos of the credit markets as it continues to skew risk-off/risk-on asset class results,” says JR Rieger in the latest Rieger Report.
He noted that the short-end of the curve for AAA munis ended on March 13 relatively cheap versus U.S. Treasury bond yields.
“The belly of the curve backed up versus the U.S. Treasury yields which also help to make munis more attractive in that maturity range. On the long end of the curve, the traditional (and old school) metric of muni yield ratio to U.S. Treasury ended the week at about 170%,” he said.
He said that while the 10-year IHS Markit AAA muni yield at month-end was 0.86%, down four basis points from month-end February, “don’t let that fool you, [there was] plenty of volatility during the last week.”
He said that compared to the 2.26% dividend yield of the SPDR S&P 500 ETF, the IHS Markit municipal bond 10-year AAA yield of 1.66% has shifted back toward being very rich from an income generation perspective relative to the equity market dividend yield.
“In my view, this is a temporary shift due to equity market downside volatility and should be considered carefully,” Rieger said.
Municipals sold off on the short end with up to 20 basis point cuts on the 1-year on the ICE Muni curve, 10 off on the short end, about 5-8 in the belly with smaller cuts out long.
Some traders said that investors are simply seeking short-term cash and the offerings out long aren’t offering that, leading to investors heading into long-duration.
Munis were weaker on Monday on the MBIS benchmark scale, with yields rising 13 basis points in the 10-year and by six basis points in the 30-year maturity. High-grades were also weaker, with yields on MBIS' AAA scale increasing by 11 basis points in the 10-year maturity and by eight basis points in the 30-year maturity.
Munis were steady on Refinitiv Municipal Market Data’s AAA benchmark scale, as the yield on both the 10-year muni and 30-year muni GO were unchanged from 1.61% and 2.32%, respectively.
The 10-year muni-to-Treasury ratio was calculated at 216.7% while the 30-year muni-to-Treasury ratio stood at 171.2%, according to MMD.
“The muni/Treasury ratios are so distorted right now that they are not very helpful as a guide to value,” Luby said. “We do think the muni/corporate ratios remain helpful.”
Stocks sunk on Monday, as all three major averages were down at least 10% in the early going Monday, causing a third stoppage in the past two weeks. Loses were cut back a little in the afternoon, with all three major indexes in the red by at least 8%.
The Dow Jones Industrial Average was down about 12.94%, the S&P 500 index was lower by 11.98% and the Nasdaq lost roughly 12.32% on Monday.
The three-month Treasury was yielding 0.233%, the Treasury two-year was yielding 0.370%, the five-year was yielding 0.505%, the 10-year was yielding 0.742% and the 30-year was yielding 1.342%.
“From a pricing perspective, we still are seeing markets perform although bid/offer spreads have widened. The team is focused on making sense of this data and responding to client inquires, which have increased,” Dos Santos said. “We believe that our combination of technology and humans makes a large difference in helping us manage the process, especially during this time of extreme volatility.”
New issues continue to be added to the day-to-day calendar as issuers pause amid this crisis. The state of Washington’s $350 million of various purpose general obligation refunding bonds and MVFT GO refunding bonds were taken off the calendar. Also placed on the day-to-day calendar was the Franklin County Convention Facilities Authority's $136 million of taxable tax and lease revenue anticipation refunding bonds.
However, the Great Lakes Water Authority, which provides water and sewer services in the Detroit area, is joining the parade of borrowers tapping a taxable structure for refunding.
The system comes to market with its more than $1.1 billion mostly refunding, taxable issue with a double-rating boost.
Fitch Ratings raised the rating the junior and senior liens one notch to A and A-plus. Moody’s Investors Service raised the ratings one notch to A2 on the junior and A1 on the senior lien thanks to the system’s strong operating performance that’s resulted in healthy coverage levels and liquidity.
Citi has the books and intends to take indications of interest Wednesday on the taxable with the pricing on all series set for Thursday, but after the turmoil of last week the timing could change.
According to the roadshow, the deal consists of $455 million water revenue bonds in four series, $40 million senior tax exempt new money, $40 million junior tax exempt new money, $329 senior taxable refunding, $46 million junior taxable refunding; $706 million sewer revenue bonds in two series, $540 senior lien taxable refunding and $166 million junior lien taxable refunding bonds.
The Fed to buy munis?
The Federal Reserve on Sunday cut its benchmark rate by a full percentage point to near zero and said it will boost its bond holdings by $700 billion to cushion the U.S. economy from the virus. That means it will buy more U.S. Treasuries and mortgage-backed securities.
Banks will be able to borrow from the discount window for as long as 90 days. The Fed will reduce reserve requirement ratios to zero percent.
Citi’s Rai said the Fed is still not buying municipal bonds.
“But they should,” he said, pointing to a recent Citi report on state and local governments.
One thing to note for the muni market is that the Fed has repeatedly balked at purchasing municipal bonds, citing that it does not have authority to do so.
According to the Citi report: “U.S. state governments are desperately searching for measures to aid its citizenry, which is reeling from this crisis. But, market volatility has constrained their ability to fund potential aid packages even further. However, if the Fed were to include municipal bonds as a part of its QE program, it would provide municipalities with a strong, permanent buyer and help stem volatility and lower funding rates. This would go a long way towards aiding state and local governments in their time of need. Smaller, weaker local issuers would probably need their parent state to access the market on their behalf, say via a conduit structure.”
The report added that all these actions might not be enough to shore up state and local finances.
“Even so, this solution is no panacea, especially since rating agencies might choose to downgrade states and municipal entities that have high debt burdens (after all, debt is still debt, even if funding rates are low),” the report said. “We would implore the rating agencies to cut state and local governments some slack in this environment. Let’s remember, they are completely blameless and struggling to cope with this crisis.”
However, other sources said that the Fed should not be buying munis. Buying bonds is about supporting credit and some participants noted that most do not want the Fed in the business of negotiating restructuring terms when that potential time might arrive.
Christine Albano, Chip Barnett, Yvette Shields and Aaron Weitzman contributed to this report.