Wishes for the next decade in municipals
Looking back on the last decade makes one realize that we have come a long way. The relatively low volatility in municipals and the steady stream of inflows from investors have shaped a rich but stable market. It is a sharp contrast to the beginning of the last decade when BABs were necessary to jump-start infrastructure spending in a high rate volatile market with some years ahead required for recovery.
Looking forward is always fraught with peril. And yet we are inclined to do so. It must be something about being human and being a part of the investor class that we do speculate about the future so often.
Here are some ruminations about the next year and decade. Caveat emptor.
- The yield curve must maintain steepness. After a scare in the summer about the inverted yield curve, we are back to an upwardly sloping curve. However, the present status also feels a bit tenuous. Negative yields in Euroland have eased a bit, but this does not represent a new direction. It is only fair that long investors should be compensated more for the risk. Is 60bps from 10 years to 30 years on the MMD GO scale really enough? We do not think so. If more competition emerges for municipals the present status could change rapidly. We have witnessed this rapidity before.
- Taxable municipals have become firmly ensconced in our market after really only one quarter of steady issuance. Buyers value this development because it serves to widen the investor base. The tax exempt crowd wonders if they will ever have enough paper to price, trade and sell. The longer term implications could grow in prominence. There is always a viable threat to the tax exemption. We do not want to tempt fate.
- The range for volume for next year appears to be approximately $420B to $460B. These are big numbers. The taxable component is a large driver of the estimates. We reached $400+B this year and few could envision that level at the start of the year. There are many reasons that issuance should stay this high over the next decade. The Northeast and Midwest need to keep rebuilding. The West and the South keep needing to bring on new capacity despite some ebbs and flows. Any infrastructure plan from the federal level would only serve to propel the activity.
- Rates are often the key to many decisions about whether to launch a bond deal or not. It now appears that there is a consensus that the Fed will sit it out next year on rate actions while the ones they have put into place to date have a chance to work. Unless inflation really starts to accelerate, these conditions may persist for the decade barring other factors such as wars, revolutions, missile firing, pandemics, etc. Perhaps, the Space Force will keep the peace along with the existing military establishment.
- The search for yield is a strong motivator. Beyond the higher risk mainstream projects, we will see more projects submit for high yield bonds that have much higher risk profiles. This sector is mainly for the institutional professionals. However, retail does seek out high yield funds and would not be insulated from jarring adjustments. Take losses and offset the gains in portfolio. Meanwhile, while all is quiet on all of the fronts, take advantage of the higher income. Corporate high yield always shows us the way when the prevailing climate is due for a change. We think over a decade there is a very strong chance that there will be more high yield credit developments but not in the next couple of years.
- Muni credit has become increasingly stable as the decade progressed. Going back to the days of recalibration of ratings, the rating spectrum outstanding has contracted along with spreads. There are many more Aa/AA category ratings than ever before. Analysts use fine gradations to differentiate credits but at times those efforts are lost on the market. The credits that depart from the norms become very well known in a relatively short period of time. Resolution of these cases can take considerable time, expense and effort. We should be further along to closure on some of the issues revolving around Puerto Rico. There is still ample time for testing legal concepts within the proceedings. All parties have a different perspective on what constitutes fair settlements. We can only hope that resolution comes well before the end of the next decade.
- Will underwriting spreads ever widen again? Most shops continue to voice complaints about compensation but continue to compete in the arena. Many forces are working hard to see that underwriting spreads do not widen for plain vanilla transactions. Municipal advisors often fill this role. But they are paid from the spread as well. If there is no relief, we will see more combinations of mid-tier firms that is already taking place.
- Any contraction in the broker dealer ranks cause fears about liquidity to rise. Liquidity is ample in the present environment. Be vigilant about changes in the perceptions and the facts over the next decade.
- Regulation continues to be a strong focus. Implementation of enhanced disclosure rules has been relatively smooth. New regulation appears to be on the back burner and it is all about enforcing what is on the books. The MSRB reorganization is a bit of an unknown until the new leader emerges. Costs of compliance will continue to climb over the decade but the rate of growth may be expected to slow a bit.
- Fewer analysts and traders are represented at various firms. There is a turnover that is going on with the generations. Municipals has always been an industry where experience counts given the arcane nature of much of what we do. These conditions will persist over the decade in isolation.
- The technology improvements continue apace. Part of the job descriptions including how good an individual was at finding the necessary information to make an informed trade. Now an informed opinion means even more and we think this concept will grow in importance over the decade for all posts in municipals.
- Transparency is a goal. Good financial reporting and reporting in the media remain key goals. These goals will continue to be prominent over the period.
We have a lot of hope for the next decade and there will be many more retirees who will be counting on the income and the stability of the municipal market even more than are doing so at present.