The bear market isn't the only cause of the municipal bond investors getting hurt. The volume of deals in the $4 trillion market has fallen, and cities and Wall Street bankers are feeling the pinch.
State and local debt sales are poised for a monthly decline of around 40% to $24 billion in September, according to data compiled by Bloomberg. Even though September is typically a busy month for debt sales, the data shows that it would be the lowest monthly volume of debt sales since November 2020.
Rising interest rates are making it less attractive for municipalities to borrow for new projects or refinance existing debt. A volatile Treasury market, the muni market tends to follow, also has cities sitting on the sidelines.
In September, issuance of municipal bonds was extremely small, said Yingchen Li, Bank of America Corp. strategist.
BofA recently slashed its forecast for bond issuance to $420 billion in 2022, compared to its initial forecast of $550 billion of sales. The original forecast was made in November 2021 before the Federal Reserve hiked interest rates to tackle rampant inflation.
According to Bloomberg, bond sales so far this year are close to $289 billion, down more than 15% from a year ago.
The decline in taxable muni-bond sales has become a popular tool to refinance debt, which has resulted in a drop in the number of bonds. The tax-cut law in 2017 stopped governments from selling tax-exempt securities for so-called advance refundings, a key debt refinancing tool.
In an interview, Ajay Thomas, head of public finance at FHN Financial, said that this year has been impacted by the lack of taxable refunds that have come to market.
Some municipalities are delaying debt sales for new projects as they look to be strategic with when they enter the market, Thomas said. He expects total muni-bond issuance to decline between 15% and 20% this year when compared to 2021.
Cities and states are being pinched by higher borrowing costs. Lynnwood, Washington, a city located about 16 miles north of Seattle, downsized a recent sale because it no longer made sense to refinance a bond deal from 2012 at current rates, according to Michelle Meyer, director of finance for the city. The city sold nearly $13 million of bonds this week instead of $28 million.
She said the market has changed dramatically since the city's last bond sale. She said it was pretty painless and referring to its 2021 deal.
Money managers may get a reprieve from the lack of issuance. Mutual funds, a key buying force in the market, are contending with outflows as retail investors continue to withdraw their money from the funds. According to the data released by Refinitiv Lipper US Fund Flows, investors pulled $3.6 billion from municipal bond mutual funds during the week ending Wednesday.
The muni market, poised for a 12% loss this year, has been under pressure due to the selling pressure, according to Bloomberg indexes.
If there is a drop in supply this year, this is the best year for that," said Trevor Smith, municipal portfolio manager at Eaton Vance Management.