COVID-19 Municipal Market Impact

The municipal securities market is going through unprecedented volatility amidst the COVID-19 pandemic. The initial “flight-to-quality” into U.S. Treasuries in early March also included a rally in the municipal sector that drove yields down to all-time lows.

The 10yr AAA MMD benchmark index reached just 78 basis points on March 9th. Less than two weeks later, it shot up 200 basis points to 2.79% as municipal funds liquidated more than $20 billion. Passage of the CARES Act provided some relief to the market last week, causing yields to rally back to 1.34% but after another route of $20 billion in fund selling Wednesday, yields have shot up about 10 – 60 basis points across the curve.

This amount of volatility typically takes years to play out, not the few short weeks we’ve experienced. However, the sky is not falling and it’s important that investors know what’s leading the price action and how to respond. We’re seeing substantial value with high-grade credits as Muni-to-Treasury ratios continue to trade near all-time highs. Below are some considerations for what’s driving the market.

Massive Fund Selling

  • Retail and municipal funds represent more than two-thirds of the $3.9 trillion municipal sector. Where they go, the market follows.
  • In less than a month, $44 billion of municipal funds have been redeemed.
  • Initially, the selling was indiscriminate across the credit landscape.
  • These funds are highly leveraged which compounds the liquidity pressure and leads to more selling.
  • Equity traders are experiencing very large margin calls and need to liquidate muni positions to raise cash.

Relative Value & Fundamentals

The disconnect between Municipal and Treasury yields have created tremendous value for the Municipal sector. Muni-to-Treasury ratios reached nearly 2,400% on March 20th for 1yr paper and ratios across all terms continue to trade at all time highs. Much of the selling has been concentrated in shorter maturities, creating the highest ratios on the short end of the curve.

  • Muni-to-Treasury Ratios as of April 3, 2020
    • 1 Year: 784%
    • 5 Year: 345%
    • 10 Year: 278%
    • 30 Year: 201%

  • Yields for the 10 Year Treasury and the 10 Year AAA MMD as of April 3, 2020
    • 10 Year UST: 0.62%
    • 10 Year Muni: 1.78%

Municipal Credit

The initial liquidation of muni funds occurred across all credits. Even “Pre-Refunded” munis, which are backed by Treasuries were being sold at massive discounts. The market saw Pre-Refunded munis with 2-year maturities trade around 2% during the week of March 23rd when the 2-year Treasury was about 0.30%. Because the credit is effectively no different than the underlying Treasuries that secure the bonds, the Muni-to-Treasury ratio typically hovers around 80% for these structures. Seeing these trade at ratios above 600% is a clear indication that credit wasn’t a factor.

That type of disconnect in credit presents opportunities for buyers. That being said, the COVID-19 outbreak will impact the municipal credit space. We recommend investors stick to only the highest grade credit profiles such as General Obligation and Essential Purpose Revenue bonds with secured liens on revenue streams. See our most recent Municipal Credit Update here regarding COVID-19’s impact.

Muni-to-Treasury Ratios: 2020 Year-to-Date

COVID-19 Municipal Market Impact Chart

What to Watch For

We’re truly in uncharted territory right now. The impact from the COVID-19 pandemic cannot be underestimated. However, there are market disruptions at play that don’t line up with the fundamental landscape. We will likely continue to experience more volatility in the coming weeks or even months until we settle into more normal price behavior. For now, continue to watch for opportunities and remain focussed on the highest grade credit sectors for relative value.

The Baker Group is one of the nation’s largest independently owned securities firms specializing in investment portfolio management for community financial institutions.

Since 1979, we’ve helped our clients improve decision-making, manage interest rate risk, and maximize investment portfolio performance. Our proven approach of total resource integration utilizes software and products developed by Baker’s Software Solutions* combined with the firm’s investment experience and advice.

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For More Information
The Baker Group's Drew Simmons

Drew Simmons

Senior Vice President/Public Finance
The Baker Group LP

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