Higher rates, stagnant volume, volatility top industry concerns

Municipal interest rates will climb higher by yearend, market volatility will be the biggest challenge facing the industry heading into 2024 and issuance is likely to remain stagnant next year. 

That’s according to respondents to The Bond Buyer’s Live Market Survey at the California Public Finance conference last week. The survey, sponsored by Fitch Ratings, showed 59% of respondents expecting rates to close out 2024 higher than current levels, 3% lower and 38% expecting them to remain about the same. 

Economic data lends itself to rates staying where they are, or possibly higher, said Warren “Bo” Daniels, managing director and head of public finance at Loop Capital Markets.

“I think as you drill deeper … we have a resilient economy that’s hanging in there, a strong jobs market, and when the government pours $8.5 trillion in the economy, and not just the fiscal policy, but also the monetary policy where we’ve had free money for a long time, is going to also add to inflation,” Daniels said. “So the combination of all those factors are going to lead to rates staying up.”

A whopping 77% of respondents said that issuance will be about the same as 2022 and 2023, between $320 billion and $380 billion, while 10% said it would rebound to 2020/2021 levels of more than $450 billion and 13% said it would fall lower. 

“This is a tricky question as an underwriter because I’d like to be optimistic that issuance will go up,” said Marcus Peters, director at Stifel. “However, I think if I had to answer honestly, it would be kind of flat issuance.”

“I think the lack of refunding opportunities has obviously taken out a huge portion of the market,” he said. At the local level, some school districts and municipalities are going to be waiting for the 2024 election cycle before confirming new issues, Peters added.

“The really big bang for your buck is going to be in November and those November elections don’t get certified until December,” he said. “That pushes out any elected bond issuances really into the first part of 2025.”

Daniels agreed, saying Loop thinks issuance will come in somewhere between $350 billion to $400 billion next year. 

“We think new-money issuance will probably hang around $250 billion; that’s been pretty consistent,” Daniels said.

In terms of potential refundings, Daniels expects “maybe $100 billion, and that is if rates kind of hang in there with us.” 

“The wild card to get us to $400 billion is whether or not rates rally in the second half of the year, maybe taxable advance refundings come back,” he added.

Tony Hughes, managing director at Barclays Capital, said he expects issuance to be lower because of two factors: First, taxable refundings, even if they were to return, won’t compensate for the supply deficit. 

The second factor, he said, is the stalemate in Washington, which he sees as “being extraordinarily problematic for large scale projects where they’re looking for a federal match, whether it’s transportation or transit.”

If an issuer is waiting for a 20%, 30%, 40% federal match, and it is uncertain to come because of dysfunction in Washington, “I think that’s a problem. I think some of these larger infrastructure projects, they’re going to be moving a little bit slower.”

Respondents said the top concern for issuers going forward is inflation and rising rates, with 47% choosing it over pension liabilities (19%), affordable housing (21%), effects of climate change and weather events (5%), Federal regulatory changes at 5% and cybersecurity threats at 3%. 

Peters said inflation is one of the chief concerns that affects all state and local governments.

“If you were to tell me at the beginning of the year that the Fed was going to get to 5.5%, hike the Fed funds rate 11 times, and we were only going to be at 4.1% inflation when their their target inflation rate is 2%, I would say you’re crazy,” he said. “We’re going to continue to see inflation, and inflation erodes the dollar value, it makes projects more expensive to finance.”

Arlene Bohner, managing director and head of Fitch Ratings’ U.S. Public Finance department, who moderated the panel, also said inflation and rising rates would have the largest impact on issuers as monetary policy tightening and inflation “have really increased the risks of a recession, which we think is likely to happen in the first half of 2024.”

That type of pressure on states and locals “could escalate particularly if that brings a marked reduction in wages and income, and also consumer spending, which up til now has been pretty resilient. We’re already seeing rising costs for borrowing for construction, for labor, and these are all impacting budgets at this point.” 

Despite these challenges, nearly half of respondents, 46%, said state and local governments were in a moderately good position to weather economic uncertainties, 18% said they were in a good position, 33% said they were in a moderately weaker position and 3% said a much weaker position. 

Peters said he spent the first four years of his career as a credit analyst at Franklin Templeton. “Every underwriting I do, I dive into the ACRF or the POS and I go back to my old self and, and look at these different credit metrics and over the last year, I’m pretty astounded by how good credit is to this day,” he said. “I think we learned as an industry a lot during the financial crisis, and issuers weren’t nearly as prepared as they are today.”

However, Bohner said, for the most part, states and local governments “are really well positioned to withstand what we think will be a pretty mild economic downturn in 2024.”

The biggest challenge to the public finance industry at large remains market volatility. Forty-six percent of respondents named it their top concern, with a recession or economic downturn at 33%, 10% said the federal elections, 7% geopolitical tensions, 3% the reduction of COVID-era federal aid for issuers and 1% said regulatory changes, such as Federal Data Transparency Act implementation. 

Daniels said if a recession hits, that “impacts everybody and that will be a key dynamic.” 

“But I’m going to go with market volatility because it impacts our market so substantially.”

Daniels said market participants need to adjust their mindsets, noting the current market is vastly different than that of January 2022 when the 10-year Treasury was at 1.63% and now it’s nearly 5%. 

“How we price deals, how we take risk and how we’re going to proceed with doing our business because we had a prolonged period of stable and low rates and now we’re going into another period of continued higher rates; it’s going to be difficult,” he said.

“I think we’re going to get through it because our market is amazingly resilient and strong,” he added.