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What Happened to the Muni Market?

Municipal debt has held up quite well amid recent market volatility. But then things started to unravel.

Munis had their worst week in nearly a year, and investors pulled $113 out of muni bond funds for the week as of last Thursday.

But it wasn’t outflows that sparked the decline. It was new debt issuance. State and local governments sold $8.8 billion in new bonds…the most this year. Through August, issuance has averaged something like $4.9 billion a week. But in the past three weeks the average jumped to $7.45 billion (according to Citigroup). That increased issuance means that a glut of supply is weighing on the market.

But that’s no surprise. The recent drop in Treasury yields has meant lower borrowing costs for state and local governments. And lower borrowing costs make municipalities more willing to take on additional debt.

This marks a bit of a shift in the muni market. Just a couple of months ago, a lack of supply was propping up prices (issuance dropped at the end of last year with the expiration of the Build America Bond program). Munis are up 8.3% for the year as of last Wednesday. And defaults have amounted to $1.1 billion…a quarter of last year’s total. And tax revenue has been up for seven consecutive quarters.

But supply in the muni space has become a challenge, and may continue to weigh on the market. New debt issuance will total $10.58 billion in the next thirty days, according to Bloomberg. And the market will be forced to absorb that additional supply.

Technically, municipal debt has been a buy since the spring. But I stand by what I said about munis a couple of months ago: the problems facing state and local governments are long-term in nature. At this point, there is no compelling reason to enter the muni space, and without that, I would leave well enough alone.

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