As we approach the end of 2021, the big question for all financial markets is how the federal,monetary and fiscal policies are going to shift to address various market forces like inflation, economic recovery, supply chain chaos and short- to long-term impacts of COVID-19.
Since the start of the pandemic, the federal government has had numerous interventions in the form of fiscal stimulus for individuals, businesses and local & state governments, which, when paired with the reopening of the U.S. economy, resulted in peak growth for the economy in the 2nd quarter of this year. However, in the upcoming months, the economic growth will likely be tamed and the markets will likely experience a normalized expansion. It’s also important to note that the recently signed, bi-partisan, infrastructure bill has a spending plan spread over many years, which will continue to add to the economic growth for years.
In this article, we will take a closer look at some of the market forces and how they are impacting the municipal bond markets; in addition, we will explore the federal government’s approach in the current times.
Be sure to check our Municipal Bonds Channel to stay up to date with the latest trends in municipal financing.
The Outlook on Federal Policies
In the recent FOMC meetings, the Fed chair has indicated their intentions to start tapering the speed of quantitative easing (QE) before the end of the year — this is primarily to address the modest growth in the economy due to the revival of businesses post-pandemic and the inflation expectation, the impacts of which can already be seen. When we assess the strength of the US economy, we tend to review the data surrounding Gross Domestic Product and its variations over the years; however, with the Delta variant still being prevalent in the community, paired with the supply chain disruptions and the labor shortages, these will continue to be a drag on the economic output.
Although we are seeing a reduction in the unemployment numbers, we will need to ensure that workforce participation is climbing back to its pre-pandemic levels. The recent data published by the Bureau of Labor and Statistics, the labor force participation rate showed the rate is improving and the wage growth is also evident in many open positions throughout the United States. The Fed’s fiscal and monetary policies and any proposed changes are dictated by all the aforementioned economic indicators that then determines that course. The recent publication by Nuveen Securities reflects on the federal government’s stance that it correctly predicted this period of higher-than-normal inflation, and is more tolerant of exceeding its 2% long-term target. The components of the price indices that are boosting inflation above the 2% target are a small sliver of overall CPI. Supply chain issues and workforce shortages in certain sectors have contributed to inflationary spikes, but these instances should be temporary. The fixed income markets are anticipating a continued period of the federal government purchasing longer-term Treasury debt that will keep the fed funds rate low. As a result, the Treasury and municipal yield curves steepened slightly during the third quarter.
It’s also important to note that amongst reviewing all the economic indicators like unemployment and labor participation rate along with temporary supply and demand imbalances, the investor concerns are growing, and monetary and fiscal stimulus programs are playing a role in today’s inflationary environment.
Don’t forget to check our Muni Bond Screener.
Review of the Municipal Debt Markets
The fate and the outlook of municipal markets look good with the infrastructure package and the allocation of federal funds coming to local and state economies for various projects; as aforementioned, these projects will not only create well paying jobs in local economies, but also add financial value over multiple years. These municipal debt markets were already strong with their activity; but, now paired with the fiscal interventions, the markets will continue to grow.
With the continued low interest rate environment, the municipal debt markets set some issuance records in 2020, and 2021 is not far behind on issuances and refundings, with the municipal governments accessing the capital markets. For example, in 2020, the new issuance of debt exceeded $450 billion of which taxable municipal debt accounted for roughly 30% and a large portion of the debt refunding also included taxable debt deals that were used to refund tax-exempt debt. In 2021, the taxable municipal debt issuance was 23% of the total municipal debt issuances, which amounted to $320 billion. Along the same lines, the refunding volumes were also down from 2021 and entailed a smaller portion of the refunded debt as taxable municipal debt.
When looking at the investor demand in municipal debt for 2021, the funds witnessed a consistent positive flow into open-end mutual funds which entailed $10.5 billion, $9.6 billion and $5.5 billion in July, August and September, respectively. High-yield municipal fund flows were $2.6 billion, $2.3 billion and $740 million, respectively. As municipalities emerge from the COVID-19, investors are encouraged by the strength of various revenue sources for local and state governments and how they were able to weather the storm during the pandemic.
Check out the implications of the American Rescue Plan Act on local and state governments here.
The Bottom Line
Looking at the supply and demand of municipal debt along with the robust fiscal health of municipalities, investors will continue to see a strong growth in the municipal debt markets. The infrastructure bill will likely exacerbate the growth with cities and other local governments tackling their long overdue infrastructure projects that could have a combined funding source of federal funds and municipal debt issuances.
Sign up for our free newsletter to get the latest news on municipal bonds delivered to your inbox.