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The economic downturn caused by the coronavirus pandemic is creating havoc in one of the sleepiest sectors of the bond market that is a favorite among wealthy investors, the municipal bond market.
The muni market has experienced unprecedented swings in yields and prices because of the growing economic impact of COVID-19 on state and localities, who are at the front lines fighting the pandemic.
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While health care costs are growing, sometimes exponentially, state and local revenues are falling because of businesses closing or operating at a fraction of their usual capacity.
"There has been more volatility in the last three weeks than the muni market has ever seen," said Matt Fabian, a partner at Municipal Market Analytics, an independent research firm.
Chris Brigati, head of municipal trading at Advisors Asset Management, said he's "been concerned about some event that would create a liquidity challenge to the muni market and some point and now we've found it."
The liquidity challenge in the muni market was evident in trading from mid- to late March, when the spread between the AAA-rated long-term muni bond index and the 10-year Treasury swelled to over 200 basis points in the span of about two weeks. Massive redemptions by muni bond mutual funds were a major catalyst. Nuveen reportedly tried to unload $700 million worth of munis in one day.
The muni-Treasury spread subsequently narrowed to about 65 basis points after the Federal Reserve announced a backstop for state and local governments, by adding short-term muni debt as collateral to a lending facility for money market funds, and Congress approved a $2.2 trillion emergency economic package. The package includes about $150 billion in direct aid to state and local governments and $274 billion for COVID-19 response efforts and less than $40 billion in block grants and school and child care funding.
No money was allocated for states to close their budget gaps, which are growing because of falling tax revenues and increased costs for health care and other services. The Treasury's three-month delay in the federal tax filing deadline will also postpone payments of state and local taxes.
