Outperformance at risk in the $4 trillion US money market


In a bleak year for fixed income markets, US municipal bonds issued by state and local governments have emerged as among the least bad assets to own. The superior performance now looks more crisp.

The $4 trillion mon market, which is often bought by individual investors who are attracted to their returns and tax benefits, has fallen 13 percent this year, according to the ICE BofA municipal bond index. The decline was sharp in the money market but less severe than benchmarks treasury bondsor investment grade corporate debt or US stocks.

Municipal finances are still in good shape thanks to the catalysts they received in the Covid-19 crisis, but their bond yields reflect more than that. Investors and strategists warn that the relative strength of the market also reflects a significant slowdown in issuance and poor pricing in the market.

The trend has been particularly evident since the end of September monise It rose while the supply of new bond issues declined.

Bar chart of change in 2022 to date (%) showing municipal bonds dodging worst market sell-off

Issuance of bonds used by governments to fund projects such as building schools or bridges in the year to September was the lowest since the first three quarters of 2019. Only $25.8 billion of deals were put on the market in September, the slowest month since March 2020 at the start of the pandemic. .

Some are now seeing a modest increase in new offerings, a supply that threatens to put pressure on prices. Issuance soared to $10 billion last week, and Citigroup expects to issue $10 billion again this week.

“I would have liked to make an upbeat call of conviction, but I can’t,” said Vikram Rai, Citi’s head of municipal strategy. “When the show goes up in the coming weeks, Munis’ outperformance will fizzle out.”

Borrowing costs are rising as the Fed pays off interest rates higher, which could force municipalities to move to avoid higher rates.

Decreased tax receipts may also result in new issues being issued. According to the latest data from the Urban Institute, the state’s inflation-adjusted tax revenue fell 0.7 percent during July and August compared to the same two months a year earlier.

Municipalities also often rush to issue bonds before elections, fearing a change in policy.

“October is usually a big month, but we’ll see,” said Peter Block, managing director at Ramirez & Co., an investment bank that specializes in municipal debt. Which we planned for October so things settle down. But if you have to issue, you have to issue.”

Munis are typically an asset that is bought and held, owned by investors who collect tax-deductible interest payments to maturity. Uneven trading means that prices in the market often do not reflect current sentiment.

More issuance could boost trading volumes and liquidity, and set new prices for bonds that haven’t traded for weeks during a volatile period in the Treasury and other fixed income markets.

“Senseless pricing is the hallmark of Money Market. It has always been an outdated, inefficient market with shoddy price discovery,” said Stephen Gray, chief investment officer of hedge fund Gray Value Management. “Everyone holds their noses and looks the other way.”

The gap between the estimated money market valuation and actual market prices is particularly wide at the moment due to the volatility of the market this year, said Nick Venditi, fund portfolio manager at Allspring Global Investments.

This is potentially dangerous for less sophisticated buyers, especially if they are buying bonds at or near [price evaluation determined by third-party providers]”They’re buying those bonds at levels that are almost certainly inflated,” said Venditi.

If the issuance fails to increase, the lack of liquidity in the market may continue to support prices.

“If you’re talking about performance [a muni] An index, if all liquid bonds are going to price overnight where they’re supposed to be trading, then you’ll obviously have a major index adjustment. “If the bonds don’t trade, nothing will,” said Michael Fox, head of municipal research at Barclays, who does not expect money to fall due to issuance or liquidity.


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