Bond volume projections revised lower amid higher rates

Several market participants have revised their initial 2023 supply projections downward as rising interest rates have sent taxable and refunding issuance plummeting, and continued market volatility has kept some issuers on the sidelines.

All the firms The Bond Buyer spoke to agree issuance will not hit the highs seen in 2020 and 2021, but they are split on whether issuance will surpass the $384.086 billion of debt issued in 2022.

Initial forecast projections for the year featured a wide range, with a high of $500 billion from BofA Securities and $450 billion to $480 billion from Citigroup Global Markets to a low of $302 billion to $375 billion from Janney Montgomery Scott and $350 billion from HilltopSecurities. These predictions were based on the Federal Reserve wrapping up its tightening cycle, the return of investor demand, macro uncertainty subsiding, the slowing of tax collections and lower levels of volatility.

Few predicted the Fed’s prolonged rate hiking cycle or the banking sector crisis, which led to further market volatility.

These events, along with others, have prompted market participants in most instances to lower their original forecasts. Issuance currently stands at $160.507 billion, down 19.5% from $199.387 billion at this time last year.

Barclays has revised its projection from $400 billion downward to a range between $355 billion and $375 billion. 

Barclays analysts Mikhail Foux, Clare Pickering and Mayur Patel pointed to the sharply rising interest rates as an ongoing theme of the year, suggesting it was a factor in the drop in refunding and taxable issuance. 

“The sharp rise in interest rates made refunding economics unappealing for municipalities, especially on low-coupon debt, whose refinancing can no longer provide net present value savings to issuers,” they said. 

This year’s taxable issuance has been slightly lower than Barclays’ analysts expected, and in line with taxable issuance pre-COVID. 

However, the Barclays analysts wrote, “the pace of refundings and taxable issuance has not declined versus our expectations, and the main reason for slow supply this year is a decline in new money.”

“The supply of taxable bonds with corporate CUSIPs has been even lower than our already low forecast going into the year,” they said.  

The Barclays analysts expect the second half of the year to be more robust, projecting that issuance will increase by 15% to 25%. They note, “issuance was 18% higher in second halves than in first halves since 2016.” 

Barclays projects “net issuance will likely reach $50 billion, the fifth consecutive year of positive net supply.”

Refundings, they said, will be in line with their expectations, but there should be “more new money as a number of issuers were likely sitting on the sidelines waiting for lower rates, and at some point they should be forced into action, and the debt ceiling situation possibly kept some issuers at bay.”

Tom Kozlik, managing director and head of public policy and municipal strategy at HilltopSecurities, initially predicted 2023 would see $350 billion of muni bond issuance.

While “the pace through the first five months of the year is slightly below our forecast, we still think $350 billion is a good forecast,” he said. “Nothing meaningful has changed since November 2022 (when we initially published our forecast) that would lead us to think issuance will deviate from our initial expectation — not yet anyway.”

He added there is “no way” 2023 issuance will be on par with the $384 billion seen in 2022, since “economic growth is lower and interest rates are much, much higher.”

To meet Hilltop’s projections of $350 billion, issuance would have to average $29 billion per month. The first five months of the year averaged $27 billion a month.

Therefore, to hit that projection, Kozlik said activity needs to pick up by $2 billion a month. This, he said, is possible, but concedes issuance may be closer to $300 billion than $350 billion.

Jeff Lipton, head of municipal research and strategy at Oppenheimer & Co., originally predicted issuance would be $410 billion this year. He now believes issuance will be lower, falling to between $320 billion and $340 billion.

“We’re seeing more market volatility, more monetary policy uncertainty, more restrictive policy than the market envisioned at the end of last year,” he said.

Additionally, he said, interest rates are significantly higher than expected, and there will be continued issuer concerns over monetary policy.

“So all of that goes into the need to revise downward,” he said.

“I can’t imagine anything higher than $350 billion,” he said.

Pat Luby, a CreditSights strategist, had originally predicted issuance would be around $415 billion. Since then, he revised it downward to $375 billion.

“The futures market is still forecasting a yearend fed funds target rate that would be higher than it is right now,” he said.

While CreditSights does not necessarily agree with that, Luby said, issuers and investment banks “certainly look at that.”

“When studying the feasibility of refinancing, some issuers will probably slow down their new-issue or new-money borrowing,” he said.

However, he does not believe the pace of new-money borrowing will “slow further from what it has already so far this year.” Luby does expect an uptick in the pace of refunding following the clarity from the debt ceiling and the Fed being done, or close to being done, raising rates.

Budgetary pressures on state and local governments are the “wildcard,” with Luby noting there are “some very large budget holes opening up in some of the big states and that can affect the pace of borrowing.”

Matt Fabian, a partner at Municipal Market Analytics, initially forecast between $435 billion and $450 billion for 2023. In April, he lowered his estimate of the year’s issuance to between $400 billion and $425 billion, which includes as little as $300 billion of tax-exempts.

In his April report, Fabian wrote, “the downside case is clearly growing so long as rising borrowing costs — via the Fed — and project costs — via inflation — fail to stabilize.”

Vikram Rai, head of Citi’s Municipal Strategy group, initially forecast supply to be between $450 billion and $480 billion. He has since revised his forecast downward to around $400 billion, which he said could be a “heavy lift.”

There are 28 weeks remaining in 2023, and to hit the $400 billion mark, issuance would need to be around $240 billion for the rest of the year, he said. This would equate to around $8.62 billion per week, which Rai called a “very tall order.”

Due to this, he is skeptical that issuance will meet the revised estimate of $400 billion and he said he may soon revise his forecast further downward.

BofA Securities did not have a mid-year revision, but the firm did revise its forecast downward at the end of Q1, from $500 billion to $400 billion. 

Issuance in Q1 2023, at about $73 billion, was about 30% lower than issuance in Q1 2022, and 28% lower than BofA forecast, the company said in its revised forecast at the end of March. 

“Both new money and refunding have been below our expectations,” the report said, although analysts said refunding volumes are “not very disappointing, given the level of market rates and volatilities in 1Q23.”

BofA described the low volume of new money as “surprising” and analysts were less optimistic that new money issuance would increase in the remainder of the year. 

“We think new-money issuance’s pattern is less likely to increase materially versus our original expectation in 1H23,” BofA’s revised forecast said. “We may need to wait deep into 2H23 to see any clear change happening.”

However, not all market participants have decided to revise their initial forecasts, especially those who were bearish in their predictions at the end of 2022.  

Alice Cheng, a municipal credit analyst at Janney Montgomery Scott, also opted to not revise her forecast of issuance falling to between $302 billion and $375 billion. She believes issuance will land somewhere around the midpoint at $345 billion.

The Fed’s pace of hiking rates is slowing down, she said, with the Federal Open Market Committee opting to skip a rate hike at its June meeting. This will most likely be followed by just one or two more rate hikes this year.

At the start of the year, she thought the Fed’s terminal rate would be in the range of 4.75%-5%. Cheng now believes it will be around 5.25%-5.50%.

“While [it’s] not entirely what the market has wanted it to be, we believe that will set a new floor for the market to move forward with more certainty, instead of just trying to wait it out and figuring out what the next step would be,” she said.

Due to this clarity, she expects issuance to tick up slightly for the rest of the year.

The slowdown with the rate hikes, she said, may help munis catch up with total returns, which will hopefully entice some investors to come back to the muni space.