Why is the municipal market selling at such a premium? I have been asked this question several times in the last few weeks — not by career municipal analysts at mutual funds or rating agencies, but sophisticated investors who are trying to make sense of the asset class. The counterpoint is coming from writers forecasting the collapse of municipal bonds. How do we reconcile this disconnect? For one, the supply/demand dynamics have changed significantly since a year ago. Aside from fear of tax increases propelling more buyers into the tax exempt shelter, there is another factor: BABs. The Build America Bond program has grown to $97 billion, as of the end of April, according to Treasury’s May 12 release — or 20% of the municipal market since the program’s inception in April 2009. (BABs are taxable municipal bonds; the borrower receives a 35% reimbursement from the federal government – on the theory that this creates a neutral rate compared with tax exempt bonds.) But this 20% understates the recent trend. A closer look shows that BABs issuance in recent months hovered around 25% of the new issue market. All taxable municipal bonds issued in 2010 through April amounted to a whopping 33% of the market according to the Bond Buyer market statistics. These changes have expanded the buyer base for municipals to those wanting long term public sector debt, but not affected by the US tax code, such as foreign buyers, pension funds and certain corporate investors — limiting supply of paper for the traditional tax exempt investor. This is not to mention that most BABs are structured at the long end of the curve, squeezing tax exempts into the shorter end — since most issuers will structure both into a single offering. (Except of course for Illinois, which prohibits a mixed structure –hunh?) The pattern is likely to continue in the foreseeable future as Congress extends the taxable BAB structure, although market dynamics may shift modestly when the subsidy is reduced to a more logical 28%.
So how’s the economy? The recent Bureau of Labor Statistics jobs report was encouraging. We created 290,000 jobs last month. Unemployment notched up to 9.9%, but this is to be expected at the early stages of recovery. As signs of recovery emerge, more people enter the job market, and if that’s proportionately more than new job creation, the unemployment rate will go up. (The unemployment rate expresses the ratio between the number of jobs and number of people counted as part of the labor market. So if everyone stopped looking for work, unemployment would go down.) In fact, 805,000 people entered the labor market last month far more than the number of jobs created.
Not to be a downer, but many of the new jobs are temporary hires for the decennial Census count. According to the BLS, the federal government employed 154,000 people for the census count as of April, an increase of 66,000 over the prior month. This increase followed hiring of 48,000 in February. Don’t get me wrong, these jobs will infuse spending into the economy, ease unemployment for many and get an important count accomplished. But they are temporary jobs that will peel off around the same time that other federal stimulus programs wind down.
Another factor slowing down the recovery is the lack of migration. The housing mess is a contributing factor. We noted in a previous post the first-time reversal of migration patterns since those statistics were collected. We have always been a nation of restless movers – opportunity seekers since the founding of the U.S. In large part this has contributed to the active municipal bond market for infrastructure growth and development. As jobs moved from north to south, east to west, city to suburb, people and development followed. In the current economy, this trend has reversed in many places.
William Frey, the noted demographer, stated in a recent report for the Brookings Institution:
The detailed 2010 census results won’t be available for another year. But this week (back in March, ed.) the Census Bureau unveiled its latest population estimates for metropolitan areas and counties for the year ending last July. What they show is a country that is demographically standing still.
Last week, the Census bureau reported an uptick in the migration rate in 2009, from 11.9% to 12.5%. But the majority of movers went from one county to another within the same state while job moves are typically inter-state. Further, renters moved at five times the rate of homeowners. Homeowners, already battered by the housing downturn are finding it difficult to move to better jobs (or jobs at all) when they cannot sell their homes.