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Short term treasuries are 'overvalued': BlackRock Muni Bonds Head

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BlackRock Muni Bonds Head Peter Hayes joins the On the Move panel to discuss why muni bonds have begun to lose steam.

Video Transcript

- We want to talk about a specific in the fixed income sector, which would be the state of municipal bonds. And one of the people who does that best is BlackRock's municipal head, the municipal bonds group head at BlackRock, Peter Hayes. It's good to have you here, Peter.

Forgive my word stumble as I introduce you. It's good to have you here. I wanted to ask you, in August you've pointed out that there was a bit of a slowdown in the municipal bond market. But for those people who want to perhaps protect income, and still get some kind of decent return, muni bonds are a place to go, say over short term treasuries, right?

PETER HAYES: Oh, they definitely are. When you look at the pickup in yield, and obviously the higher tax rate you are, the bigger the beneficiary you would be of tax-free nature of the income. So it's an important component.

I would say short-term treasuries, a short-term part of the market, probably a bit overvalued. The fed, as we know, is going to keep rates on hold for the foreseeable future.

There's a lot of money piling into that part of the market. So there's probably a little bit of value by going a bit further out the curve, especially if you want to pick up income.

- Hey Peter, it's Julie here. I think we talked about this last time you were on, the fact that we are going to see a lot of budget shortfalls around the country, particularly if Congress indeed does not pass stimulus giving states and municipalities more aid.

So now that we're a couple months on from the last time we had this conversation, I'm just curious how you think that's going to affect the municipal bond market. Are we going to see a lot more issuance, for example?

PETER HAYES: So we've seen a lot of issuance. It's been interesting, and it's a little bit of the flip side of Adam's question, is yes there's value as income. But the market has had a significant snapback since the volatility that we saw in March and April.

And I heard your last guest talk about some of the steps and measures the Fed has taken to help some of those markets, corporate bonds, high yield, mortgage-backed treasuries. It really only indirectly has helped the municipal market.

So we've seen a tremendous snapback in prices without the help of the Fed. And to get to your question, despite economic fundamentals, you know, we talked in August about the shortfall, which is enormous. And the economy still is doing better.

But it's still at a fraction of pre-COVID levels. And until it returns to pre-COVID levels, the revenues on the part of states and cities, even airports, mass transit, toll roads, seaports, et cetera, is a vast part of the market's impacted by this revenue shortfall. Until we see that return to pre-COVID levels, the pressure is going to exist.

And I think one of the keys is that the market is somewhat ignoring the fundamentals as we see them, in this big shortfall that you talk about. They're hopeful of another stimulus package. They're hopeful of some Fed intervention.

They're hopeful that the reopening is successful. But current financial conditions don't warrant necessarily, the valuations, that we're seeing in the market today.

JARED BLIKRE: Jared Blikre here. I just want to ask you who has exposure to the muni market if there is no fiscal stimulus, and it starts to roll over? If we see some cracks in it, who's going to get hurt?

PETER HAYES: If the market in general begins? Well, it's typically a retail-driven market. You know, there's a sort of appeal to the higher the tax rate is I mentioned earlier, the bigger the benefit of a tax-free income.

So it typically is owned by higher net worth individuals. It's not true. When you look at the tax rate of a lot of the ownership of municipals, it actually is down the spectrum further than most people think. But when you look at the Fed data, it's widely owned by retail investors.

Now, it's important and it actually-- so it gets to the question about how many-- what are the cracks in the market look like? And the cracks in the market look like probably rating downgrades, some financial pressure, et cetera. The high yield part of the market, very speculative.

Not a lot of investors really moved to that part of the market, unless they're willing to take that kind of risk. That's where we see a lot more pressure, perhaps defaults, things like nursing homes, stadiums, et cetera. You think about the behavioral changes the pandemic has impacted.

That's likely to impact those sectors. But the investment-grade part of the market, your general obligation bonds, your school districts, your airports and hospitals, not likely to see widespread defaults. They have a lot of tools that they can maneuver in order to help themselves out of this financial quandary.

We're talking about budget cuts in several states, now. That's one vehicle, increase in taxes is another. So there's a bunch of different things that can take place. So you have to, I think, define what those cracks mean. But clearly, the retail investor would be impacted, should there be something widespread that we're likely not expecting.

- So Peter, based on everything you just said, there's going to be some kind of stimulus at some point. And in the note to your clients, you talked about preferring a barbell strategy. Tell us how what you just said, because there is pressure without funding right now for a lot of states and municipalities, what your barbell strategy really means.

PETER HAYES: So one of the things we like here is cash. And cash isn't that attractive. Cash rates are low. But it does give you some pretty good insulation. As I mentioned, fundamentals aren't really in line with valuations. The market has snapped back quite a bit.

Julie asked about issuance. Issuance has been elevated, and it's likely to be elevated. So we think there's better buying opportunities ahead. So we want to keep some of that powder dry, some in cash. So that's kind of the front end of that barbell, if you will.

And then the other side of that barbell is more in the 10 to 15 year part of the curve. You know, you asked about the short term. I said it's a little bit overvalued.

But by moving out to 10 or 15 years, you can pick up some income and still not take the risk you would take in a 20- or 30-year security. So that's kind of the barbell. And if you want to define it a little bit better you could say perhaps it's a short barbell, given the cash and the 10- to 15-year nature.