Peter Franks, director of municipal analysis at Refinitiv MMD, gives his take on the ongoing volatility in munis — and all markets — with some historical perspectives on where we've been and where we are headed. Lynne Funk hosts. (34 minutes)
Transcript below:
00;00;04 - 00;00;17
Lynne Funk
Hello everyone, and welcome to another Bond Buyer podcast. I'm Lynne Funk, Innovation Editor at the Bond Buyer and with me today is Peter Franks, director of market analysis U.S. Municipal Bonds, Refinitiv MMD. Welcome, Peter.
00;00;19;00 - 00;00;20;26
Peter Franks
Thank you, Lynne. A pleasure to be here with you.
00;00;22 - 00;00;50
Lynne Funk
Great. So we are here to talk about the muni bond market. It's been quite an interesting market to start 2022. And as we record this on March 11th, it was a heck of a week to get through once again in the muni bond market. I guess we just want to ask you, can you start to talk a little bit of where we have come in 2022? It's volatility galore. What's happened so far in 2022 from what you've seen.
00;01;00 - 00;01;30
Peter Franks
You know it's really interesting because it's March 11th and it's very, very close to the same time period of 2020 So it's really, it's been a hell of a couple of months so far in 2022, but in reality, it's been a hell of two years. That being said, I mean obviously the COVID period was just exponential volatility, I mean the sky is falling kind of thing.
00;01;31 - 00;01;57
Peter Franks
We're not like that now, but because it's March, it's visceral. You have that feeling March. March is typically quote-unquote one of the weaker months in history through munis. This one in particular seems to be a bit stronger than that. But on top of that, you have an FOMC that's going to be raising rates next week. And they've been talking about it now for months.
00;01;58 - 00;02;22
Peter Franks
Now you have a war raging, a physical war with bombs, missiles, as opposed to the Cold War. I said in one of my pieces today, and it sounds sad, but I'd rather be talking about cold right now than Ukraine and Russia. So, yeah, it's very, very volatile. It's very it's unsettling and unsettled.
00;02;22 - 00;02;33
Peter Franks
Once again, not as horrible as March of 2020 was, but it's got that feel right now.
00;02;33 - 00;02;56
Lynne Funk
I would agree with you on all those points. That's kind of wild. I would ask you in terms of the wild sell-off in 2020, what that was credit-driven right. I mean that was credit concern-driven, not necessarily the underlying credit, but what's different in this time period than it was in 2020? What can we point out that's different in the market?
00;03;01 - 00;03;40
Peter Franks
Well the credits are actually stronger than in 2020. If you want to compare that. I know your question is really about the first quarter of 2022, but the difference is that you know credits are stronger. They received a lot of stimulus money. States didn't have to spend a lot of money in some areas they had to spend tons of money in other areas — health concerns — theoretically, Build Back Better money for infrastructure might lighten their load going forward from a municipal standpoint.
00;03;40- 00;04;10
Peter Franks
More people who chose to move somewhere else. Where now you have a housing market that is crazy. There's more income from that for municipalities. So that the credit picture is actually better than it was in 2020. There was a fear of everything in 2020. Munis had a bid in 2020, but rather dropped off quickly.
00;04;10 - 00;04;36
Peter Franks
So just fear of everything. Fear of the unknown. And then we had massive stimulus, which stemmed the sell-off of all assets and we went through that period of 2021 where it was like tighter than tight. You wrote about it yesterday when I mentioned that we went to 1% in one year for the first time since 2020.
It actually hit 0.05% in one year in April of 2021. And here we are back at 1%. Oddly enough, one on three, today with today's adjustments, which was the actual number from the last time we were near 1%, but interest rates are rising. The Fed is taking away stimulus. They're going to raise rates.
00;05;08 - 00;05;39
Peter Franks
It's just we're trying to get back to where we were somewhere between 2016 and 2018 after the last crisis after the taper tantrum of 2013 and the elections of 2016.
But we all live through this. We write about it, we listen to it, read and we write and we write. And let's face it, what they're trying to get back to some sort of normalcy where there isn't fiscal policy, monetary policy that's moving rates a certain way other than market demands. So rates are rising. We'll find out next week to what extent but the credit picture is better.
00;06;10 - 00;06;28
Peter Franks
It's just a, you know, 2% to 2% on the 10 year. It was 1.72% a week ago. 30 basis points long, long munis are down 23 basis points this week as of 3:00 this afternoon, in our estimation.
00;06;34 - 00;06;46
Lynne Funk
Right. So your one year, is it a 1.03% and the 10-year started 2022 at 1.04% if I recall correctly.
00;06;46 - 00;06;49
Peter Franks
Yeah, right about there. That's crazy.
00;06;49 - 00;06;49
Lynne Funk
Pretty wild.
00;06;50 - 00;06;59
Peter Franks
Yeah. I don't know if you noticed today but the seven and 10-year Treasuries up and they still are, they're inverted.
00;07;00 - 00;07;03
Lynne Funk
So what does that mean?
00;07;06 - 00;07;39
Peter Franks
I can do like the Wall Street Journal that said that the yield on the seven year is higher than that of the 10 year. It's reacting to what's going to happen next week and many FOMC meetings to come. You know the argument is, was it going to be 50 basis points the first time? Now with more pressure on there's more pressure on supply right because of the Russian Ukraine situation, there's more pressure on Europe to do what they need to do while they're hunkering down waiting to find out what happens with this war.
00;07;41 - 00;08;08
Peter Franks
Seemingly on Omicron and COVID are waning. They're not waning in the Western Pacific, but here in the States and in Europe, so things are getting better or we're about to get better. But it's almost like rates needs to go up because of inflation, but they don't want to raise them too high too fast because they're worried about stagflation, because you can't get anything done right now.
00;08;09 - 00;08;32
Peter Franks
There are plenty of workers. There's plenty of demand. There's no supply. And it's getting worse with this commodity situation with Russia. And the rest of the world. So again, not an economist, but we're all involved in reading about it. Every day is putting our face, 24-seven on top of coming out of COVID and then this happening.
00;08;32 - 00;08;42
Peter Franks
It's a one-two punch. You know, how they're going to navigate it is yet to be seen. We'll start to learn more about that next week on Wednesday at 2:00.
00;08;44 - 00;09;11
Lynne Funk
Right. Definitely feels like it's just been piled on. In terms of munis, how would you say this volatility, all of this, is affecting pricing in the market? I mean, not only, supply is less, that's for sure. I mean, some folks think that's been a sort of a good thing for the market.
00;09;13 - 00;09;35
Peter Franks
It doesn't hurt that supply is less, especially in these in these strenuous times when there's a lack of depth to the bid, when there's more customer selling, the last thing you need is more supply. Oddly enough, supply next week drops again. This week was not oversupplied, and it's $2.3 billion New York PITs this week.
00;09;35 - 00;10;08
Peter Franks
So that's the bulk of next week's supply. The volatility, the selling, interest rates rising — it's taking a lot of the depth of the market out. There are less bidders, there's less risk being taken. You can see it even in trades and cross trades.
00;10;08;09 - 00;10;31;09
Peter Franks
I bought these off the list at X and I'm selling them up four or five basis points. Now two or three months ago, that'll be up in 01. You buy it from a customer and you go to sell it to another customer. You know that the selling cost would be limited if you had an order up five from where you were buying them.
00;10;31 - 00;10;49
Peter Franks
He's happy to have your liquidity. He's paying for it. So I think one of my headlines the other day was, you know, liquidity at a price. Yeah. I mean, you have to be realistic. All right? You don't like my bid, I'm down to the nickel. You have to pay me for the risk to take on the bonds because I'm not sure if I'm going to have that order.
00;10;49 - 00;11;15
Peter Franks
And if I'm going to have that order, I'm not going to come back and give you yours back. You know, just I could be hanging here with these bonds tomorrow down another five. It's very risky times out there. And there's not a lot of depth to the bidside. Reports I got this week were lots of bids wanted, fewer bids, bigger covers, bonds not trading.
00;11;16 - 00;11;27
Peter Franks
You know, some funds are locked into events where if the bid isn't anywhere close to the eval, they won't sell them because that's how they measure themselves.
00;11;29 - 00;11;51
Peter Franks
Others are more free to do what they want. And we'll make a market call. Yeah. You come in first thing in the morning, and it sounds like it's going to hit the fan and you get out and all of a sudden later on, it got a little bit better. There were some trades this morning that were weaker than trades this afternoon.
00;11;51- 00;12;12
Peter Franks
They're still all weak, but they weren't as weak. Didn't mean that it was up. I don't know the at the end of the day today, it almost felt as if maybe somebody was kicking tires. A look around, but not going into a weekend with a war going on that could potentially become even more catastrophic and heading into next week with the Fed.
00;12;13 - 00;12;16
Peter Franks
So even if they're kicking tires, boy, they're not kicking them hard.
00;12;20 - 00;12;43
Lynne Funk
So when you know, you mentioned bids wanted, it looks like as of today, Friday, March 11th, there have been 19 sessions since the start of 2022 where the bids wanted have risen above $1 billion. And of course, as you well know in 2021 there were two times that that occurred and that was in early February of 2021.
00;12;44 - 00;13;10
Lynne Funk
When you're seeing all this, all these bonds out for the bid, a lot of folks talk about liquidity. There's not as many people willing to come out and take risk. From your perspective, if this pressure continues and the fund flows continue.
00;13;10 - 00;13;15
Lynne Funk
Maybe we can talk a little bit about fund flows. How are those correlated in the market right now?
00;13;16 - 00;13;42
Peter Franks
Well, some of those fund flows are the genesis for some of the bids wanteds. Depending on the fund and the timeliness of it. You know, we Lipper, as part of Refinitiv and Lipper gives their report on Thursday through the week ending that Wednesday.
00;13;42 - 00;14;16
Peter Franks
Mortgage-backed securities have had 14 consecutive weeks of outflows, equity funds have it. It seems like everybody's had outflow. Where's the money going? Well, they're not buying Treasuries because they're going down too. The writing is on the wall, we are raising rates.
00;14;17 - 00;14;44
Peter Franks
What are you going to do? There's a big gap between the one-year and the two-year, and the next step is about 25 basis points.
But so the 2023 is being hung in there just because, all right, I don't like a 1% yield, but it's only for another eight months nine months, 10 months. I can live with that because rates are going to be higher. You know it's the same ladder situation, right, if you have to employ money and you do a five-year ladder every year, 20% of your money's coming due.
00;15;08 - 00;15;28
Peter Franks
So if rates are going higher, you're reinvesting your money at a higher rate. If rates are going lower, you know, you've got 80% of your money earning and you have to take the time out in the ladder and then reinvest at a lower rate. For right now, money's being put in cash, I assume.
00;15;28 - 00;15;35
Peter Franks
But there's a lot of selling and not a lot of bids. And the only one thing that occurs when that happens, rates get higher.
00;15;36- 00;15;39
Lynne Funk
And we're going to take a short break, but we'll be right back.
00;15;44 - 00;16;08
Lynne Funk
And we're back with Peter Franks from Refinitiv MMD. So let's pivot here for a second, and I want to talk to you about credit spreads. What what's the picture there? Are we seeing some widening? What sectors are widening?
Generally since 2021 was just so tight, and now investment-grade rates are up, so is that giving investors a little bit more sway to demand more across the ratings universe?
00;16;30 - 00;16;35
Peter Franks
Well, demand more, I'm not sure if that's the right word.
00;16;37 - 00;16;57
Peter Franks
We spoke in 2021 quite often about the quest for yield. When you're talking about the one-year being at 0.05%, I mean you couldn't even buy a 10-year piece of paper and cover your annual fee for your account.
00;16;57 - 00;17;27
Peter Franks
They're going to charge you 1% on your first million dollars and you're only earning 4.5% while you're double down bid. Triple-A and double-A were on top of each other. A-rated was only just a few short basis points behind that. Look at Illinois, which jumped some 75-80 basis points last year.
00;17;28 - 00;18;00
Peter Franks
Pennsylvania, Connecticut, New Jersey, crazy crazy tightening and what's happened as rates have been getting higher and, you know, triple-A GOs, the creme de la creme, where you could get, I remember it was back in January, I think oh my gosh. Or maybe late early February, you can get 1% in 10 years and now it's a 1.80%.
00;18;03 - 00;18;33
Peter Franks
I can, even if it's down 30, and I'll buy a triple-A piece of paper that I would prefer for my portfolio at a nice new rate, you know, some, some 80 basis points behind where it was last year. So there has been a decompression of all that and by sector, AMT has got a little bit wider.
00;18;33 - 00;19;23
Peter Franks
Usually, airports are AMTs, they've gotten particularly wider. What's really gotten beat up badly is the coupon curves, right? The 3s, you almost never see a 2 handle around anymore. You probably need to hold them to maturity at this point. De minimis factors come in. De minimis was a big deal back in the 90s and in 2008-09 it was a big deal, and it's coming back again. Last year and the year before, we had a couple of folks chiming in with us, 'why don't you write a 4% as your main curve'? We said, well five still works. We have coupon curves, we can extrapolate things.
00;19;23 - 00;20;06
Peter Franks
There is about a 25 basis points spread for 4% coupon, but it's 65 to 70 for a 3% coupon whereas just a few months ago it was 38 to 48 for the 3% coupon and 12 to 15 for the 4% coupon. So those sub-four coupons that spread out wider and faster than say an A-rated credit, or a credit that was insured or whatever it may be, there's a little bit more spread now.
00;20;07 - 00;20;31
Peter Franks
You know, one of my personal favorites is New York City Waters. Yes. One of the quintessential essential service bonds. And yet with all the New York paper that's flooded the market the end of last year, beginning of this year, it's just one big ball. It's almost indiscernible, whether it's double-A waters, double-A PITs.
00;20;31 - 00;20;46
Peter Franks
It's one basket seemingly attractive. But again, rates are going higher. So you're buying something at an attractive price if you have to buy, it's one thing. But if you have the time to pick and choose you to wait for rates to go up.
00;20;48 - 00;21;07
Lynne Funks
So that's pretty much the question then, right? How far, how high does it have to go before buyers start stepping in? Is there really a concern that we're going to go much, much higher? Is it sort of let's see what this rate hike does?
00;21;08 - 00;21;39
Peter Franks
I'm not 100% sure of how much time a fund manager has to hold cash as opposed to employing it. I asked that question of somebody a year ago and they gave me an answer. And I had to ask again. Different funds obviously have different answers and not every buyer of bonds is a fund. It could be an individual. Our strategist Dan Berger, wrote the last few weeks of fund flows.
00;21;40 - 00;21;45
Peter Franks
You know, as rates are increasing, the fund flows outflows seem to be increasing.
00;21;47 - 00;22;16
Peter Franks
And somebody points out at some point that will reverse. We haven't found that moment yet. We haven't. You know, I think we're still in discovery mode. The market will let you know. I think that until we find out what force monetary policy is going to take, it's still going to be a little bit more of the Okay Corral and once we get a better look at it, and if you don't get the guidance out of next week's meeting, then you got to wait for the following month.
00;22;19 - 00;22;28
Peter Franks
To see a bit more guidance. And I think that will set the tone. On top of that, you still have COVID you still have a war raging in Europe.
00;22;31 - 00;23;07
Peter Franks
Let's not go there. I mean, I don't want to talk about that. That's it could get really ugly. But if peace breaks out guess what? Rates are going up. Right now, the war is putting more words of inflation and disruption in the flow of metals and materials and gas for consumers, which is going to put another dent in productivity and GDP, especially in Europe, so as a whole new set up, a whole new ball of wax.
00;23;08 - 00;23;16
Peter Franks
You're just get getting through COVID and now you got this to deal with. It's uncertain times, I think unsettled doesn't even cover it.
00;23;17 - 00;23;23
Lynne Funk
I was just going to say unsettled. And then I was thinking, is there even and it's just it's I mean, it's pretty horrible, actually.
00;23;24 - 00;23;44
Lynne Funk
I guess maybe what I can ask you to what are some positive things that you could see coming down the pike for munis?
00;23;46 - 00;24;26
Peter Franks
There's an improved credit picture, positive. The barrier to entry for people who couldn't or wouldn't want to be involved in security that, you know, 1% or 2% returns are seeing opportunity to get better returns, especially on an after-tax basis. Credit is better there, there were more enhanced credits in 2021 and going into 2022, than there were downgrades.
00;24;28 - 00;24;38
Peter Franks
So that's positive. Does the stimulus help? It is helping out Illinois short-term for sure. In the long-term will they be able to manage it? Don't know.
There's still a lot of money in state coffers that has not yet been used. And a lot of their tax collections are up you know, vis-a-vis home values.
00;25;19 - 00;25;43
Peter Franks
People are still shopping. They're just not going to the malls to shop. They're buying online or, you know, they're doing this. And forget the fact that gas is at $4.50 a gallon or whatever it may be. Will that curtail things, yes. I could tell a kind of half-joke the other day that some tollway bonds were trading really weak compared to a week ago.
00;25;44 - 00;25;49
Peter Franks
Well with gas at $4 a gallon, how many people are going to be getting on that highway, you know?
00;25;50 - 00;25;51
Lynne Funk
Right. Right.
00;25;51 - 00;26;11
Peter Franks
Look at the amount of people that don't go across the Triborough bridge every day any more. Maybe there are more now that people are actually going back into the office and not wanting to get on to public transport. But I think ridership in the subway is up to like 2 to 3 million a day now, which is 100% more than it was last year.
00;26;11 - 00;26;14
Peter Franks
But it's still down 50% of what it used to be.
00;26;15 - 00;26;26
Lynne Funk
Right. I mean, I go into our offices maybe, maybe twice a week and, you know, so I'm certainly not participating in that, beefing up the ridership.
00;26;27 - 00;26;42
Peter Franks
So the silver lining is that states credits are in better shape, children are going to be able to switch on and off from in school and at home learning. So maybe they'll never be a snow day again.
00;26;43 - 00;26;45
Lynne Funk
Oh, that's going to be disappointing.
00;26;45 - 00;27;10
Peter Franks
I know. I think I heard that on the news the other day that in New York they going to do away with snow days.
00;27;10 - 00;27;38
Peter Franks
A lot of people get to live where they think they want to live now, work remotely. It's amazing how well our entire trading world worked in that first year of COVID; it's amazing. I mean the technology that was put into place, look look at us now we're on a podcast, but we're on a screen face to face 25 miles away.
00;27;38 - 00;27;45
Peter Franks
You know it's yeah it's ridiculous especially for an old dog like me. Oh yeah.
Lynne Funk
Well, Peter, is there anything you think that we didn't touch on that you wanted to to to to touch on before we leave the audience?
00;27;59 - 00;28;07
Peter Franks
I know you you kind of gave me a nice outline the other day when you asked me to become a guest on your podcast. I appreciate that. I truly do.
00;28;09 - 00;28;15
Peter Franks
Well, one thing that you're working hard on. I know, and we are too is ESG.
00;28;15 - 00;28;18
Lynne Funk
Oh, yes. How could we not talk about ESG?
00;28;18 - 00;28;57
Peter Franks
Everyone in the whole world is talking about ESG. From our perspective, I think one of the questions that a lot of people ask, is does it make a difference, as far as is it getting any kind of extra premium? We haven't seen it yet. It might be opening up doors for funds and new, younger investors who are adamant about governance and sustainability and being green.
00;28;57 - 00;29;23
Peter Franks
And there are funds and there are bonds that are labeled green or social that can go into those funds and they serve that buyer, which is great. The other question is, are you really green? You know, I guess MSRB put out of a request for information recently.
00;29;32 - 00;30;05
Peter Frank
And you know, how are they going to be essentially identified as ESG? Yeah, you can say they are, but who who's going to verify it. There are a couple of verifiers out there now. But it's different sources. So you have to trust your source. So that's the question. Will in time will there be a little bit of a premium for any issue.
00;30;05 - 00;30;13
Peter Franks
But there may be. There may be. But let's face it, everybody wants something cheap, so why pay more?
00;30;14- 00;30;37
Lynne Funk
So the question I have and I have been asking lately, because it always feel as though from an issuers perspective, they ask, where's the cost-benefit? Where's this greenium? Where I kind of flip that question and that is, as this grows and yes, the definitions are still murky and, you know, not universal, might there be a penalty in the future if they don't?
00;30;38 - 00;30;50
Lynne Funk
I think that's something that you know, as investors do change and have more demands. I guess that would be my question for the muni issuer community is, will they pay a penalty?
00;30;50 - 00;31;34
Peter Franks
That's a great question. I mean, are you saying will there be a penalty if in fact they labeled themselves as a green bond and it turns out not to be, no, you lied or could it? I'm not 100% sure on this. And the issuer market would be a lot better place to ask. It's not my expertise, but I do believe for your state, your city, your locality or X amount of debt versus income, but you're going to do a green bond, there is a little bit more leeway.
00;31;35 - 00;32;17
Peter Franks
They can expand their debt ratio. If it's a green bond and does that help them or not? I mean, that just gives them more debt and you're not getting paid a premium for that bond. To what end? I mean, if you have to do it to get clean water, of course, you know you need to do it and you should be allowed to expand your debt level to give the essential service of clean water or clean air or a better sewer system or better housing but at what cost? Does it put that town, that city, that state further in jeopardy?
00;32;38 - 00;32;56
Lynne Funk
I actually was even more even referring to a penalty in terms of pricing. If they don't label, if they don't at least disclose, the risks or the opportunities with their deals.
00;32;57 - 00;33;18
Peter Franks
I mean, I guess if the labeling body is, isn't everybody has the same one and it's not in check, then maybe not because then it's just a bond. And you say, yeah, it's just a bond. Even if it is green right now, it's traded just like bond but maybe in the future, there is a premium for that green bond.
00;33;19 - 00;33;41
Peter Franks
So I'm not sure. I mean, it's a work in progress, right? This is what, been probably two or three years now that it's a tip of the tongue kind of word? It'll gain traction.
00;33;46 - 00;33;55
Peter Franks
But you want to hope that, you know, hope and pray that the bonds that are being issued for those purposes and is stated as such complete the purpose at the end of the day.
00;33;56 - 00;34;22
Lynne Funk
Well, Peter, thank you so much for your time. I hope that the next time that we are chatting, it might even be in person. Thank you again for being here.
00;34;23 - 00;34;24
Peter Franks
Thank you very much for having us.
00;34;24 - 00;34;46
Lynne Funk
Thank you for listening to the Bond Buyer podcast. I produced this episode with audio production by WenWyst Jean-Marie. Special thanks to this week's guest, Peter Franks of Refinitiv, MMD. Read us, review us and subscribe to our content at www.bondbuyer.com/subscribe. From the Bond Buyer, I'm Lynne Funk, and thank you for listening.