Could the municipal bond market see refunding volume rise later this year if the Federal Reserve Board pauses or lowers interest rates in the aftermath of the market-stirring collapse at Silicon Valley and Signature banks? Most likely not, according to municipal market experts.
“While the SVB collapse added significant volatility into the financial markets, I don’t believe it will materially change the thinking of the Federal Reserve,” said Roberto Roffo, managing director and portfolio manager at SWBC Investment Company.
It’s difficult now to predict if the banking collapse foreshadows a deeper problem in the financial markets over the longer term, he said, but he doesn’t believe it will make enough of an impact to change the Fed’s decision-making process or lead to a substantial increase in refunding supply — even if interest rates decrease.
“[Federal Reserve Board] Chairman [Jerome] Powell has made it clear that they will continue to raise short-term rates as long as it takes to tame inflation,” he explained. “SVB just served as a reminder that they need to be careful.”
While a significant drop in long-term interest rates could potentially increase refunding volume, Roffo and other market sources don’t believe a volume spike would be substantial — if one occurs.
The majority of large issuers, Roffo said, are fundamentally sound and the extended period of ultra-low interest rates has reduced their need to restructure debt — unless rates drop “precipitously,” which he doesn’t expect.
While others could envision some impact on rates given the events of this week, they don’t expect it to be enough to materialize into a swell of refunding volume.
Cooper Howard, fixed income strategist focused on municipals at Charles Schwab, said he would not be surprised if the Fed pauses its rate hiking cycle “until the dust has settled” from the banking collapses.
At the same time, however, he isn’t optimistic for increased refunding volume.
“I don’t believe that it will have a material impact on refunding supply later this year,” Howard said. “Most bonds that were good candidates for refundings have already been refunded when rates were lower earlier last year,” he added.
A pause in rates wouldn’t be enough to spur refundings, agreed Tom Kozlik, head of public policy and municipal strategy at HilltopSecurities Inc.
“Interest rates would need to fall hundreds of basis points to create a meaningful level of primary market refunding activity,” he said. Recent events haven’t changed Kozlik’s forecast.
“The municipal market was a passenger on the roller coaster ride the financial markets experienced, but I don’t believe there is an immediate impact,” Roffo explained.
Muni yields fell Monday between six and 12 basis points and the tax-exempt market followed the flight to quality in Treasuries after federal regulators stepped in as a result of the collapse of California-based Silicon Valley Bank and New York-based Signature Bank over the weekend.
“Munis are taking a backseat and are following the direction of Treasuries, which continue to be highly volatile following the developments of Silicon Valley Bank,” Howard said.
The U.S. Treasury, Federal Reserve Board, and the Financial Deposit Insurance Corp. announced they would fully protect all depositors who had funds in SVB and Signature, just days after regulators took control.
SVP invested in long-term debt, like Treasury bonds, which offered steady, modest returns during low rate environments.
But when the economy overheated after more than a year of pandemic stimulus, SVB was left unprotected as the Fed began raising rates to quell inflation.
Their once-safe Treasury investments looked less attractive as newer government bonds offered more interest in the higher rate environment.
Silicon Valley Bank provided banking services to nearly half the country’s venture capital-backed technology and life-science companies, according to its website, and to more than 2,500 venture capital firms.