The municipal market: Enough crosscurrents to make a whitewater rafter dizzy
No doubt, the credit side of the municipal market got a bit of a boost from the potential positive news out of Pfizer on a coronavirus vaccine. We would make the case the good news out of Pfizer, as tentative as it is, may be getting another boost from the strong likelihood that, if it works, the new administration will be far more effective than the old one would have been in getting it produced and distributed.
Distribution, after all, is no small thing for a vaccine that needs to be stored at minus 94 degrees Fahrenheit, and for which two injections are required.
Meanwhile, although long-term Treasury yields are up about 30 basis points since the end of July, short-term yields are almost nonexistent (2 years at 0.19%). And that has helped support demand for munis.
That said, the market now has a bit of a “hope against hope” feel to it, given just how awful the pandemic crisis has become nationwide, with daily new cases approaching 180,000, hospitalizations at a record 68,000 nationally, and daily deaths approaching 1,400. (We also note what we have been observing for some time: as CNN observes, “ Recovering Covid-19 patients struggle to return to normal after hospital discharge, study finds.”)
It is difficult to see how the magnitude of all three pieces of data won’t get worse in the coming months, as more and more of the nation enters peak flu and cold season and as more commercial activity is forced indoors.
That said, the announcement on the vaccine is certainly great news, but as medical experts warn, there is much that we do not know yet in terms of the potential for side effects, the length of time of any protection generated, and other issues that tend to crop up this early in Phase 3 for any new medication.
Given all of that, there are still a large number of variables that are likely to affect municipal credits before a successful vaccine is approved, production and distribution reaches critical mass, and the economic effects of the virus-induced downturn begin to turn around, sharply. The biggest positive out of all of this, aside from the potential that a vaccine will be available soon, is that many economists believe there is rather vast pent-up demand on the other side of this crisis.
In the meantime, state and local government credits have a vast number of issues with which to contend as we seek credit equilibrium:
1) Whether we get a substantial pandemic relief package out of Congress — i.e., out of the Senate. Quite simply, unless Democrats manage to flip the Senate with two wins in Georgia (where the races look very tight), any pandemic relief package is likely to be a tiny fraction of the $3 trillion the House passed — possibly more like $500 billion to $600 billion, and entirely omitting support for state and local governments. And, the timing of such a package remains uncertain. This, we note, contrasts with a recent interview with Paul Krugman, who suggested that the aggregate economy needs “several hundred billion per month” to keep from continuing to erode severely.
In the absence of such a large relief package — seemingly impossible with the Senate in Republican hands — negative economic momentum is likely to continue well beyond the peak of the pandemic, and even a well-distributed vaccine would not prevent that.
A strong case can be made that yields on the highest-quality paper will retain their recent absolute and relative rally, which has seen 10- and 30-year yields down to roughly 90% of Treasury yields on the best paper.
However, the credit concerns for virus-affected sectors remain mostly intact. These sectors include a) farebox-based mass transit, b) airports, c) toll roads, d) universities, e) gaming-based credits, and f) nursing home and long-term care facilities.
In addition, there are concerns about the housing sector problems in lower-income communities. Housing is an unusual sector right now in that medium-to-higher priced homes in many communities are seeing rather spectacular demand, while weaker communities face sharply increased evictions and foreclosures, unless the Federal government actually comes up with a sizable coronavirus package — sharply and quickly.
"We really are still very much in the disaster relief stage," Krugman told CNBC. “A lot of people are going to be out of work, a lot of businesses are going to be stressed. We need to just make life tolerable for them," he added.
We would add to that the strong need for support for state and local governments, including the weakened sectors noted above but also including funding of state and local government support activity for individuals and families with severely deteriorated or nonexistent income.
Looking out a little further…
1) A more progressive tax structure. Once again, we are back at the political fork in the road. With Republicans running the Senate, there won’t be any change. However, should Democrats win both Georgia seats and a 50-50 tie, there will likely be quick work on a more progressive income tax code for individuals, possibly a modest wealth tax, and a move on the corporate income tax rate from the current 21% level to around 28%. Of course, any increases in income tax rates, whether on individuals or corporations, would help the muni market, by boosting taxable equivalent yields in both sectors.
2) A crying need for infrastructure spending, but with so little funding available. On Nov. 10, the Bond Buyer included an article on future federal infrastructure plans. There is much more to be written about this, but in our view, a key issue is that state and local governments simply do not have the revenue sources available in this economic environment to pledge to repayment of debt service. Consequently, without coronavirus relief for state and local governments, and subsequent funding relief for a key portion of state and local government infrastructure project capacity, very little is likely to be accomplished.
This, of course flies in the face of vast, needed project activity, including deteriorated existing facilities, adaptation to impending technological change, and vast spending needs for climate change related projects, including sustainability and carbon mitigation.
There is a sharp distinction between financing capacity — which is widely available — and funding capacity, which provides the needed pledged revenues for any long-term project.
The latter is why new-money issuance in the muni market has remained so very modest for so very long: state and local governments are very limited in their funding capacity, and have been promised for years the Federal government would step in and provide support. Clearly, it hasn’t happened as yet, and the ongoing coronavirus crisis is extremely unlikely to permit additional support any time soon.
3) Over a relatively short time frame, governments will have to adapt to changes in labor-related behaviors that may not revert to historical patterns. This includes, for example, more permanence in some work-from-home activities, and on the climate change side, moves away from severe weather-related activities, including floods, hurricanes, fires, and droughts.
4) It also remains to be seen how rapidly tourism patterns return to normal, even after vaccine distribution occurs.
While interest rates remain extremely low, and investor demand high, state and local governments still face severe headwinds and mounting unknowns as the pandemic continues its destruction.