‘Painful’ Budget Cuts May Boost Munis in 2012, RBC’s Mauro Says
States closed more than $325 billion of deficits in the last four fiscal years with spending cuts and additional revenue, according to the National Association of State Budget Officers. These balanced budgets have helped municipal bonds return more to investors this year than U.S. Treasuries, stocks, corporate bonds and commodities, even as Harrisburg, Pennsylvania, and Jefferson County, Alabama, filed for bankruptcy.
Chris Mauro, head of U.S. municipal strategy at RBC Capital Markets, discussed what’s to come for municipal bonds in 2012 during an interview at Bloomberg’s New York office for today’s issue of the Bloomberg Brief: Municipal Market newsletter.
Q: What is it that went right for the municipal bond market in 2011?
A: The sky didn’t fall in. The worst didn’t happen. And more importantly, people saw state and local governments manage through a very difficult budget season this year, and balance their budgets in a responsible way without a lot of gimmicks or one-shots. It was painful, but the states and local governments did what needed to be done.
Q: What is your outlook for the municipal-bond market in 2012?
A: We’re set up for a good 2012. Volume won’t be too bad and the state fiscal situation is much improved from last year. It’s still a little fragile -- the revenue growth the states are experiencing is on a thin foundation and susceptible to domestic and global economic slowdown.
The two big risks we see for the market are what’s going to happen to the economy and what comes out of our federal government. Despite the fact that the supercommittee failed and the “Gang of Six” didn’t accomplish much, we think this deficit reduction discussion will continue into 2012, and it will be a part of the presidential election narrative.
You don’t have a meaningful discussion on deficit reduction unless you have tax reform and entitlement reform as components. And if you look at those two things, munis are both losers.
Q: With the anticipation that yields will rise in 2012, why be in the market now?
A: You’re going to be in the market on the longer end because the yield curve is so steep. Even with a correction, you’re going to be outperforming if you go 15 years and out.
If you look at the fund flows, and look at the participation in the market and where it has rallied, most of that has been in short- and intermediate-term paper. There’s no question that will continue to be the case. People will try to keep their money short and protect themselves from a back-off in rates.
Q: What are you telling your clients to buy right now?
A: You go down the credit curve. It has been a high-grade game for most of this year. We wouldn’t want people going too far down the credit curve, but certainly the mid-range A type paper and the 15-year and longer paper would be the area that probably has the most potential.
People are going to gravitate toward the intermediate -- 10 years and under -- segment of the curve, the AA or better big issuers, and familiar names. That’s the sector that has done the best this year. There may be a little more juice there, but I doubt it.
Q: What do you expect next year in terms of defaults?
A: There isn’t any reason to believe next year will be considerably different from this year. Some of the more notable fiscal-distress candidates were one-off situations and isolated events and not evidence of any systemic issue in the market.
Are you going to get a small community that got over its skis and can’t pay its bills? Yeah, sure. There’s a lot of stress at the local level, there’s no doubt about that. But we don’t think it’s going to be systemic.
Q: Will the elections next year have an effect on where the market goes?
A: The political dimension will be focused on the U.S. deficit-reduction initiatives. That’s going to be a centerpiece of the narrative in the presidential campaign. As we saw this past year with discussion of tax reform, it makes the market nervous.
In terms of broad policies, we have to wait to see how both candidates articulate their views as they relate to state and local governments.
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