Saturday, May 30, 2020

Distortion in fixed income - Corporates versus Munis

The Fed programs for corporate bonds have started strongly with billions in corporate bonds purchased through ETFs. These purchases will include firms on the verge of bankruptcy, no questions asked as long as it is included in the ETF benchmark. It has also caused a surge in new debt issuance. A municipal bond program, the Municipal Liquidity Facility, has been announced but details have not been finalized.  

Given the differences in program timing and size, there is a distortion between corporate and municipal bond spreads after accounting for taxes. 
This spread difference will likely close once the liquidity facility starts to kick in. Investors should think about these relative spread opportunities; however, the special risks of state and municipals should be apparent. States are not diversified nationally, and their lockdown policies will have a direct impact credit quality and relative supply issuance. Nevertheless, the muni-corporate opportunities may be one of the better places to look for fixed income value. 

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