How Trump's trade war brinkmanship impacts the muni market
Municipal issuers are benefiting from lower interest rates and investor demand that seem at least partly driven by the nearly constant talk of tariffs and trade wars, though in the longer term that volatility could hurt credit.
Market participants discussed the effect of trade uncertainty after President Donald Trump last week rescinded his plans to impose a 5% tariff on Mexican imports, saying he had reached an agreement with Mexico to reduce the flow of migrants through the border.
Mexico is the U.S.’s second-largest trading partner, totaling about $671 billion in goods and services last year, according to the U.S. Trade Representative. Trump said in 2018 that trade wars are "good" and "easy to win," and has not been shy to threaten the use of tariffs against countries he believes are treating the U.S. "unfairly."
In May, the U.S. increased existing tariffs to 25% from 10% on more than $300 billion of imports from China and reportedly contemplated more. The U.S. imported $450 billion of goods from China in 2018, the majority through seaports, according to a Fitch Ratings report.
The apparent constant threat of trade wars creates ripples in the municipal bond market as investors begin to search for safe, tax advantaged investments and borrowing costs decline.
“We see and we’ve seen for the last year or more continual inflows into the mutual funds and that’s additional money to be invested in the muni space,” said Ben Watkins, director of the Division of Bond Finance in Florida. “That means additional money to be invested, which means additional demand for munis. So that’s clearly positive for the issuer community.”
Watkins said the trade uncertainty affects the muni market indirectly through the interest rate effect, and stokes fears that global economic growth will slow.
"A year ago you had robust global growth and people were talking about how many times the Federal Reserve was going to increase interest rates in the future," Watkins said. "Now as a consequence of the trades wars and talks of tariffs, there's fear that global growth is going to go down."
It leaves central banks less able to increase rates and instead decrease them to stimulate growth to offset the potential effects of tariffs and trade wars, Watkins said.
“There’s been a significant and unexpected improvement in interest rates from a borrower’s perspective and that’s another good thing,” Watkins said.
For the municipal bond market, that means additional refundings. More issuers will move issuances up by three to six months to take advantage and lock down the low rates for future projects, Watkins said.
Tariffs could be part of a handful of explanations as to why interest rates have been low, said David Erdman, Wisconsin's capital finance director.
“Something is driving municipal rates to where they’re at right now,” Erdman said. “I don’t think many economists predicted that this is where the market would be.”
As summer approaches, normally slow months could see more activity as issuers look to take advantage of lower interest rates.
Issuers are looking to sell longer-term fixed-rate bonds because they are able to lock in lower interest rates, Erdman said.
“Supply is probably going to be a little bit heavier this summer compared to the typical summer months,” Erdman said. “I think it reflects the current market and that issuers are probably lining up some financings with a little bit of urgency to take advantage of the current market.”
A strong economy has blunted trade war effects, but it is still something to keep an eye on, analysts said.
“Trade wars are bad for the economy, but it’s a really strong economy right now and so it hasn’t tipped the balance,” said John Ceffalio, municipal credit research analyst at Alliance Bernstein. “But we are absolutely monitoring this and paying attention for its impact on credit.”
Tariffs are beginning to impact farm states such as North Dakota, South Dakota, Nebraska, Iowa and Illinois, Ceffalio said.
However, since the Dakotas and Nebraska don’t issue many municipal bonds, it isn’t having an impact on the market, Ceffalio said.
In a Moody’s report released in May, the group said China’s boycott on U.S. soybeans will dampen income in Iowa’s agricultural sector.
“An agricultural trade war with China will have an outsized impact on Iowa,” the report said.
Iowa’s total soybean exports are at about 2% of gross state product, and are larger relative to the state’s economy than all but two other states, South Dakota and North Dakota, according to Moody’s Investors Service. Moody’s estimated that Iowa’s total soybean exports to China alone were equivalent to 1% of the state’s GSP.
Inevitably, ports are affected by ongoing trade wars.
“One of the larger impacts will likely be on seaports to the extent that the tariffs have an impact on Chinese imports and exports particularly on the West Coast where there’s a lot of trade activity between those ports,” said Scott Monroe, director in Fitch Ratings’ Global Infrastructure and Project Finance group.
Revenue structures used at ports protect them in the short-to-medium term. Ports will sometimes have long-term guaranteed contracts that provide a revenue floor, helping to insulate port revenue from trade-related volume volatility, said Emma Griffith, senior director for global infrastructure at Fitch.
To date, Griffith hasn’t seen a drop-off but sees volatility as shippers try to get their volumes in before tariffs go into effect. Also, import volumes aren’t falling because production is still in China and shipped to the U.S.
That could change in the long term if producers decide to move to other countries and decide to ship to other ports, for example switching from the West Coast to the East Coast, Griffith said.
“Then you would start seeing shifts in where volumes might be coming into the United States and so that could affect some ports, but that’s a much longer-term effect,” she said.
Cranes are also becoming an issue for ports as some of the cranes used are on the tariff list. The Port of Charleston recently learned that the State Ports Authority would have to pay an extra $36 million for 12 cranes.
The American Association of Port Authorities signed on to a letter earlier this month with 140 associations to the U.S. Chamber of Commerce opposing tariffs in Mexico and supporting the United States-Mexico-Canada-Agreement — a product of the renegotiation of the North American Free Trade Agreement. NAFTA is still in effect and the USMCA would still need a Congressional vote.
"Tariffs on Mexican imports would harm U.S. consumers, workers, farmers and businesses of all sizes across all sectors, making us less competitive and undermining efforts to negotiate strong trade deals in the future,” the letter said. “We oppose unilateral tariffs and any subsequent retaliation.”