New time, place, and rules in munis

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It feels like we have stepped into a new virtual reality in the municipal market. Things are not what they appear to be any more. I recently viewed Magritte’s paintings at MOMA. Modern is a term of art when the work being appreciated is over 50 years old. But, Magritte is able to unsettle our perspective and provide depth in a two dimensional canvass. But this analogy does not do justice to the present perspective.

I think the more appropriate reference is to the character Dave going through the fourth dimension in Kubrick’s 2001: A Space Odyssey. He is not certain if he is perishing or being reborn. But, what is most important is that his perspective is being changed radically. Our perspective in this market has been sharply changed, perhaps, for a very long time.

Now that rates are below where they have been during my time on the planet, I openly wonder whether they will persist? The coronavirus is bound to put a cap on gross domestic product growth this year. Many pundits are forecasting that the effect could be as much as a drag of 0.5% or thereabouts.

Combine that potential effect with the Fed’s recent feckless cut and we may only conclude that the low rates will be with us for a good part of this year if not for the entire year.

Given the exceptionally low-rate environment, is our existing vocabulary adequate? We tend to talk of ratios and spreads. Quite frankly, even a spread product such as tobacco is not what it once was when tobacco bonds were introduced in 1999. Now the transactions are even heavily oversubscribed and very tight to the AAA scale. The Buckeye Tobacco Settlement Financing Authority's tax-exempt offering on February 26 saw the 10-year with a 5% coupon spread 50 over AAA scale.

When the 10-year Treasury is at 0.97% and the muni 10-year is at 0.96%, do we really need to talk of the Muni/Treasury ratio? Even out the curve, the status is not completely different. It appears that the time has come when we just need to focus on absolute rates. Ratios become meaningless at these levels.

The spread discussion may also be considered in the same light. Spreads were not that wide to begin with before the spreading of the coronavirus. To say that the present spread spectrum is tight does not do justice to the subject. We still can hold on to having some discussion about spreads, but, the conversation does not have to last very long.

We spend a lot of time analyzing credits as we should. We fret over whether disclosure is adequate and adhering to the rules or exceeding the baseline requirements. We also strive to be fully in compliance with all regulatory requirements with not much tolerance for interpretation. We seek guidance from the SEC and the MSRB so we may more carefully adhere to the intent of the regulations. We want to see more timeliness in the release of audits.

As much as all of these factors matter to us and should be reflected in market receptivity to a transaction, it does not really appear to matter all that much in the current market environment. Rates are being determined more in conjunction with the macro factors than the micro factors of credit.

Even spreading munis to corporates is not yielding quite as much information as it has over the last few years.

The one segment of the market that does appear to be conveying some important intelligence is the taxable municipal market.

Most of the taxable munis have been absorbed in the market just as quickly or in some cases quicker than in the tax-exempt market. The size of the transaction continues to be a focus.

Taxable buyers always favor large more liquid names a.k.a. benchmark bonds. However, even the smaller transactions are being accomplished in relatively efficient fashion.

This is the kind of market where even if Puerto Rico were to wrap up its PROMESA proceedings and came to market with a restructuring that it could get done.

The other aspect of the present environment that confounds the mind is that positive flows keep coming into the mutual funds and ETFs. It would appear that there are no factors out there that would attenuate the flow even including the extremely low rates.

Flows continue to stay positive.

Investors continue to value safety and stability in their fixed income holdings. This conviction is especially true for those who were investing back in 2008. The memories are long.

Among the other possible disruptive factors that could potentially lead to higher rates is the election. Post Super Tuesday, it would appear that some of these potential concerns may be subsiding.

Perhaps, we do not need to consult art that challenges our core perceptions and we do need not travel to the fourth dimension to be enlightened on the current circumstances. But we do need to be open to the nuances. For now, the coronavirus will keep us grounded.

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