Bonds: The $1.2T infrastructure bill is 'a positive for the municipal market,' analyst says

Jennifer Johnson, Senior Vice President and Director of Municipal Bond Research at Franklin Templeton, joins Yahoo Finance Live to discuss the impact the President Biden-backed infrastructure bill will have on the municipal bonds market, the 2022 outlook for bonds, and the rising prominence of ETF in the market.

Video Transcript

BRIAN SOZZI: All right, the Biden administration's $1.2 billion infrastructure bill could prove to be a tailwind to investors in the municipal bond market next year. Jennifer Johnson is a Senior Vice President and Director of Research for Franklin Templeton's Municipal Bond Group. Jennifer, nice to see you here.

So talk us through this.

JENNIFER JOHNSON: Thank you.

BRIAN SOZZI: How are you positioned as this bill starts to take hold throughout the economy?

JENNIFER JOHNSON: Sure. So we view this bill as a positive for the municipal market. And that is both in terms of perhaps supply, as well as credit. And what this is going to allow is, A, just infrastructure to improve across the country, which lowers costs over the long term to maintain that infrastructure. And then now we can have additional source of money to fund projects either that may already be in the works or could be things that communities couldn't have done previously.

So we do expect there to be a positive influence. We're not going to see a ton of debt issued right off the bat. This money is going to come in over five years. And these programs also take quite a bit of time to get actual shovels into the ground. So we don't expect a lot to happen in the next year. Maybe some grant anticipation notes from an issuance side. But we do expect it to be positive over the longer term.

JULIE HYMEN: And Jennifer, it's Julie here. So give us a little more detail on the opportunities-- the kind of opportunities this is going to present to muni investors and how they should be evaluating those opportunities.

JENNIFER JOHNSON: Sure. So we don't have a lot of detail yet on exactly who's going to do what or how the money is actually going to come in. Usually, funds are done on a matching basis. So the federal government will match whatever a state, local government or transit agency is already spending. So what that'll do is improve those credits because it's taking some of that debt off the balance sheet of the state and local governments or transit agencies and transferring it to the federal government.

So that should make financials look a little bit stronger, in addition to just repairing and bringing infrastructure up to speed. So we should see an improvement on credit. And then we should also see some increased supply. Again, not probably off the bat, but over five years.

Now, who issues that and how it comes-- that's what we don't know yet. But we would expect that the municipal market will play a role. The municipal market funds most infrastructure in this country. And so we think we'll play a large role in that.

BRIAN SOZZI: Jennifer, how has the pandemic-- the ongoing pandemic, I should say-- impacting the municipal bond market right now.

JENNIFER JOHNSON: Sure. Well, I mean, what a difference it's been over the last year and a half. State and local governments primarily receive tax revenues. So when you pay sales taxes, when you pay income taxes, or if you pay the toll at your local tollway. So all of those sources of revenue tightened up when the economy closed, people got laid off, people stopped going to stores and traveling and all that sort of thing.

Now, fortunately we have seen a couple of positive things happen. First, we saw state and local governments actually exhibit some really strong governance and management. We saw a good financial policies, good financial decisions, which really showed that they were conservative in trying to approach how to manage this crisis.

And then the second thing, of course, is multiple rounds of federal aid, which came in two primary portions, either a repayment for additional costs around COVID so that there was no out-of-pocket for the state and local governments. And then in some cases, actual revenue replacement money for things that weren't getting financed, things like people not riding the subway, people not having elective surgery. So that federal money was certainly crucial for those credits.

As we're looking at it now, economies are reopening over the summer, we saw some good rebounds in tourism. That slows as we come into the winter months. And of course, now we have Omicron. And so we're watching carefully to see what the impact of that is going to be over the medium and longer term. We think that state and local governments, as well as municipal agencies are in a really good position thanks to the federal aid, thanks to the conservative management and governance during the crisis.

So we're optimistic that they'll be able to manage any more bumps along the way from Omicron or whatever might come next.

JULIE HYMEN: One of the things that we know is coming next probably, most likely, in 2022 is an increase in interest rates from the Federal Reserve, right? That's something that they've telegraphed. What kind of effect do you expect that to have on the muni market?

JENNIFER JOHNSON: Sure. Well, we definitely follow higher interest rates. And of course, there's the impact on credit, which means higher borrowing costs for local governments. Rates have been at all-time lows. So certainly anything is going to seem more expensive to a local government. But relatively, it's not as much of an issue.

But what's actually more important for us is not necessarily federal interest rates, but how the muni market matches up against that. And we want to look at how munis trade to treasuries at both the high grade level, as well as down the credit spectrum. And right now we feel pretty good about things. You know, we think there's fair valuations at the high grade level. And there's definitely opportunities for spread as you move down the credit spectrum.

Spreads have tightened as state and local governments have come out of the COVID crisis. But there's still availability in there to find great opportunities for spread. And we have a deep and experienced research bench. And that's what that team does all day, is look for those opportunities where we can add value as spread.

JULIE HYMEN: Gotcha. Interesting stuff. And then finally, I want to ask you a little bit about ETFs. Mainly, ETFs. That's because there was a story recently in "The Journal" about how we have seen a lot of the incoming flows to muni bonds going to ETFs versus more sort of traditional funds. And you're on the fund side of the business, as I understand it.

Is there an effect on the overall business from this phenomenon? Certainly, we've seen it happening in other types of asset classes, right?

JENNIFER JOHNSON: Yeah, I think from our perspective, whether we're managing assets for an ETF, managing assets for a traditional long-term fund, intermediate fund, whatever, we're going to approach it the same way. You know, we're looking for value, we're looking for spread, we're looking for appropriate prices and valuations on the credits that we're adding. And then whatever appropriate credit risk given what the portfolio might be aimed at. So from the perspective of having more money coming in, it just gives us an opportunity to do more money management.

So from our perspective managing the money, we're going to think about it differently, but it's still the same municipal product in our minds.

BRIAN SOZZI: Great insights here. Jennifer Johnston, Senior Vice President and Director of Research for Franklin Templeton's Municipal Bond Group. Good to see you. Have a happy New Year.