A reluctance by states and cities to borrow is making municipal debt a star performer among credit assets and driving investors to scour the market for bonds.
(Bloomberg) — A reluctance by states and cities to borrow is making municipal debt a star performer among credit assets and driving investors to scour the market for bonds.
Municipalities issued $218 billion of long-term debt year to date, 9% less than at the same point last year and the slowest pace of sales since 2019, according to data compiled by Bloomberg. The Federal Reserve’s interest-rate increase regime since March 2022 to fight inflation at least partly explains the dropoff.
The scarcity is fueling outperformance in the asset class. Municipal bonds returned 0.4% in July, better than a 0.35% decline in US Treasuries, according to data compiled by Bloomberg. Month to date, munis lost 0.8%, less than Treasuries and corporates, which lost 1.2% and 1.8% respectively.
“Tight supply has pushed municipal bond valuations toward lofty levels,” Wells Fargo Investment Institute strategist Luis Alvarado wrote in a note published Monday. “For long-term municipal investors, we would view periods of market weakness as an opportunity to add to positions.”
With few new bonds available, portfolio managers have become reluctant to sell their current holdings. This market stasis is providing a tailwind for bond prices even as mutual funds, the core buyer of state and local debt, struggle to attract consistent inflows.
Investors ‘Starved’
“It’s keeping turnover more muted in the portfolio because there are fewer securities to source in the new issue market,” said Wesly Pate, senior portfolio manager at Income Research + Management in Boston. “The muni market is effectively starved for bonds.”
The competition among investors can be seen in the growing demand for state and local government bonds that have come to market. In July, deals were oversubscribed by 5.2 times on average, according to a research note by BlackRock Inc., above the year-to-date average of 4 times.
Greg Gizzi, head of municipal bonds at Macquarie Asset Management, sees two main reasons for the slowdown. Issuer balance sheets are fairly healthy, diminishing their need to borrow, and some issuers may be deterred by interest rate volatility. The summer is typically a period of weak supply, he added.
Not all issuers time their borrowing to the market. Tennessee is planning to issue debt this week partly to fund a grant to finance a new Nashville stadium project for the Tennessee Titans of the National Football League. Sandi Thompson, the director of state government finance for the Tennessee Comptroller of the Treasury, said that the timing was based around the calendars of other government agencies, rather than the market.
“Just because rates are going up and down, we don’t play the market, we just do what we’re supposed to do, procedurally,” Thompson said. A decline in refinancings given high interest rates has also squeezed supply, she added.
For all these reasons, there’s been little turnover of bonds by investors. Average daily bid-wanted activity fell more than $300 million in July compared to the prior month, according to data compiled by Bloomberg.
“More and more, the bond you have in the portfolio is something you want to protect,” Pate said.
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