Muni Ruble?

An associate PM gives her perspective from the trenches:

It’s been an emotional few weeks. The COVID-19 pandemic, kids at home, my husband and I at home, the kids and my husband and I at home at the same time, closed liquor stores. Oh, and then, there’s the market.

The municipal bond market, to be exact. Muni bonds, supposedly a quiet and stable segment of the market, have never seen swings like these: we started March with yields around 80 basis points (bps) on a 10-year AAA muni, and in 20 days, that number peaked at 296 bps. Part of the widening was caused by frightening news, but also by levered players unwinding positions and selling at distressed prices. The 10-year muni-to-Treasury yield ratio, usually around 80%, spiked at 600%.

At the moment, spread widening has subsided, particularly after the U.S. government’s $2 trillion infusion and the $500 billion Municipal Liquidity Facility program, which provide enough funds for now. New issue sales have been down as much as 20% in the past month, representing a drop of 56% from the same period a year ago. We expect issuance to continue to be low. However, we also saw some bashful issuers coming to market recently, and we’re actually seeing these offerings . . . oversubscribed! Also, as of Tuesday, April 14th, the 10-year AAA muni yield is back to a 1.12 level and muni variable rate demand notes (short-term borrowing) are yielding a whopping 10 bps.

Looking at rates and market activity in mid-April, I ask myself: Did March really happen? Is there really a worldwide unprecedented shut down? Not if you’re looking at rates.

Yet in New York, the pandemic is projected to add as much as $7 billion to the budget deficit. Alaska is facing a one-two punch from zero visitors and lower oil prices. Indiana’s revenue was 6% below budget for March, although the shelter-in-place order was issued only at the end of the month. Nevada and Florida have a heavy reliance on gambling, tourism and sales taxes. With the unemployment rate spiking and shopping almost non-existent, the drop in revenues for states could easily exceed the 11% drop seen during the 2008 recession. And, back then, revenues contracted, but over a period of two years—not overnight. Perhaps the financial picture isn’t all that dour. States are set to get $150 billion from Washington, and states entered this fiscal year with more robust rainy-day funds.

However, the cash infusion is earmarked for dealing with the direct costs of the pandemic only. The rainy-day funds, at most 20% of expenditures, and on average around 8%, won’t last long. With one stroke of the pen, S&P put all muni sectors on negative outlook. Illinois is in the news (again) for the questionable honor of possibly being the first U.S. state to enter below investment-grade territory.

And so, as the muni market today pretends that nothing happened in March, we at Thornburg are trimming/exiting positions that we anticipate to perform poorly over the next six to 18 months (e.g. stadiums, hotels, convention centers). Meanwhile, because we had a liquidity advantage, we were actively buying in March, oftentimes as the only bidder and adding to names at very attractive levels. We are looking forward to more realistic market levels that reflect the current economic situation.

Let me end by quoting Winston Churchill, “A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty.”