Munis in Focus: 2020 Municipal Market Update

Municipal bonds delivered mixed performance in the first half of 2020, with the investment grade portion of the market gaining 2.08% and high yield munis down 2.64%.1 The municipal market was waylaid by pandemic-fueled dislocation in the first quarter, resulting in a monthly record $44 billion in municipal fund net outflows in March alone, before federal financial support improved investor confidence and reversed fund flows.2

Unprecedented federal support has improved investor sentiment

The COVID-19 pandemic upended the U.S. economy in the first half of the year, depressing tax collections and straining budgets. With state and local governments implementing sizable austerity measures, federal support has been instrumental in propping up the municipal market. Congress provided emergency relief in the form of the CARES Act, which included $150 billion of grants to state and local governments for COVID-19-related expenditures, as well as billions of dollars in direct aid to municipal issuers – including not-for-profit healthcare facilities, transit agencies, and airports.

Supplementing federal relief measures, the Federal Reserve has provided critical monetary support in several forms, including the Municipal Liquidity Facility (MLF), which was announced in April in order to provide direct loans of up to $500 billion to states and municipalities. The initial eligibility thresholds of the MLF were later modified to include less-populated counties and cities and two revenue-bond issuers per state. However, even after cutting the spread on tax-exempt notes by 50 basis points in August, the MLF remains expensive relative to the public markets, which could limit its utility. In June, Illinois tapped the facility ­by borrowing $1.2 billion in one-year general obligation notes, and in August, New York’s Metropolitan Transportation Authority became the second issuer to utilize the MLF by borrowing $450.7 million.

This line chart depicts the cost of capital for the MLF, 3-year state of Illinois bonds, and BBB rated municipal bonds. Since Illinois tapped into the MLF, the yield on 3-year state of Illinois bonds has dipped below that of the MLF but remains higher than 3-year BBB municipal bonds.Image Pop Up

While emergency relief and Fed lending programs have helped anchor short-term borrowing rates and have buoyed investor sentiment, federal support is not a panacea for all municipal issuers. Given the severity of the pandemic’s economic shock and the scale of austerity measures, we believe more aid to state and local governments is needed.