Municipal Market Volatility and Liquidity Amid COVID-19 (March 19, 2020)

Dexter Torres and Kenneth Potts
Dexter Torres and Kenneth Potts

Given the continued market volatility, we want to make sure we continue providing clients with regular updates on the state of the municipal bond market. Please see below the market update compiled from our trading and portfolio management teams:

  • Municipals continue to cheapen today by approximately 50 basis points across the curve and are drastically underperforming
    Treasuries, which are up about 5 basis points for the day.
  • A massive flight to safety has resulted in Treasury bills showing negative yields out through 6 months.
  • Dealers are still risk averse as volatility remains extreme and markets behave abnormally. Their risk departments are tapping
    traders on the shoulder to sell positions and lighten up on inventory.
  • Large mutual fund complexes’ redemptions continue, as mutual funds keep selling their most liquid holdings such as VRDNs
    and pre-refunded bonds.
  • Dealers are holding large amounts of VRDNs tendered by funds, but with so many other opportunities buyers have been
    limited yet they are contractually required to set the rates at market clearing levels. For this reason, dealers are setting rates
    at higher levels where they think the balances will clear quickly. Over the last week, coupons for General Market VRDNS went
    from 1% to 8%.
  • Fund flows, as reported by EPFR, indicate about $11 billion in outflows over the last 7 days.
  • There is significant dislocation in bid wanted sales. Prior to this crisis, the municipal market would see $750 million out for the
    bid on a typical day. These past few days the bid lists have increased to $2 billion, and today they totaled $4.5 billion – with
    virtually no one buying. Ratios across the curve remain at elevated levels – with front end ratios north of 300%.
    Dealers are experiencing stress all the way through their back office, and trade fails have increased because so many people
    working remotely is putting stress on company infrastructures. Today, a large municipal dealer had a confirmed case of
    COVID-19 on the NJ trading desk where half their trading team was working. They shut down the desk and all traders went
    home in the middle of a big bid wanted list, this further hurt liquidity.