The muni market needed re-pricing, but now it has gotten way out of control, according to PIMCO’s Christian Stracke and Joseph Narens.
The pair explain that what’s happening right now in the muni market makes a certain amount of sense. It’s a bit like last year, when the market repriced sovereign risk to act like a credit product, rather than an interest rate product it was previously valued at. That meant yields were higher and the cost to insure the debt rose too as a result of investors realising that, yes, a sovereign could actually default.
Now that’s happening with muni bonds, but it has gotten completely out of control and there’s multiple reasons why.
- Median state debts are around 7.3% of gross state product; with local governments tacked on it is a bit above 18%. This is not comparable to sovereigns, but it shows it’s not too big.
- The average maturity date of muni debt is 16.2 years, giving some time and delaying rollover risk for the broader market.
- Muni interest costs are actually costing states less, not more, compared to history.
- Small municipalities may face imminent cash flow problems, but this isn’t likely to be a broad problem.
- Public pensions — which may eventually be a serious issue — are not yet ready to cause a significant threat.
So, while there may be some imminent problems to smaller municipalities, there is no reason to start thinking mass default. Rather, this is just an appropriate adjustment to a market’s risk dynamics.