Municipal Debt Markets And The COVID-19 Pandemic

from Liberty Street Economics

-- this post authored by Marco Cipriani, Andrew Haughwout, Ben Hyman, Anna Kovner, Gabriele La Spada, Matthew Lieber, and Shawn Nee

In March, with the outbreak of the COVID-19 pandemic in the United States, the market for municipal securities was severely stressed: mutual fund redemptions sparked unprecedented selling of municipal securities, yields increased sharply, and issuance dried up. In this post, we describe the evolution of municipal bond market conditions since the onset of the COVID-19 crisis.

We show that conditions in municipal markets have improved significantly, in part a result of the announcement and implementation of several Federal Reserve facilities. Yields have decreased substantially, mutual funds have received significant inflows, and issuance has rebounded. These improvements in municipal market conditions help ensure that state and local governments have better access to funding for critical capital investments.

Many Federal Reserve Facilities Include Municipal Securities

On March 23, partly as a response to the strains in the municipal markets, the Federal Reserve extended asset eligibility for the Money Market Mutual Fund Liquidity Facility (MMLF) and for the Commercial Paper Funding Facility (CPFF) to include certain short-term municipal securities. Then, on April 9, the Federal Reserve announced the establishment of the Municipal Liquidity Facility (MLF), which purchases short-term notes directly from municipal authorities. The MLF was designed not only to address the liquidity needs of municipal authorities but also with the explicit goal of supporting market functioning. In early June, Illinois became the first MLF borrower when it sold $1.2 billion of short term notes to the facility at a rate more than 1 percentage point below the rate at which it was previously able to access private markets in May. In addition, the Coronavirus Relief Fund, established through the CARES Act, provided $150 billion in federal fiscal support for state and local governments.

Secondary Market Conditions Have Stabilized

The chart below shows the yields on 30-year municipal bonds by credit rating. While Federal Reserve facilities focus on shorter-duration municipal securities, the 30-year yield is a common benchmark. Across all credit ratings, yields spiked up in mid-March: between March 2 and March 23, the yield on AAA securities jumped 1.8 percentage points.

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Disclaimer: The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any ...

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