Iran war isn't spooking muni buyers yet, but they're keeping eye on transportation credits

Compared to last spring, when "Liberation Day" roiled the market, municipal bond investors say the market so far is navigating the latest wave of geopolitical uncertainty like a champ.

Buysiders said they're holding firm to their strategies despite the Iran war, the rising price of oil and the threat of inflation. But they're expecting some pressure on credits like ports, airports and toll roads if the Middle East uncertainty continues.

"Munis have no fear," said Eve Lando, portfolio manager and managing directorfor Thornburg Investment Management. "Things have widened a bit, but we're not back to the levels of cheapness or attractiveness that we saw in April of last year," Lando said. "Possibly the fact that munis are a safe haven, domestic market providing essential services, maybe this will start entering into the conversation, and we'll see even more people going into munis."

Markets have seen some volatility since the U.S. and Israel launched a war against Iran on Feb. 28, a move that disrupted the global flow of oil. Last week, the volatility prompted a few bond issuers to hit the pause button. Munis have since firmed slightly to start the week, as the new-issue calendar fell below $10 billion due to the Federal Reserve meeting. This week's deals have enjoyed strong demand, investors said.

There is still a lot of money out there, and market participants seem comfortable putting it to work, said Peter Delahunt, managing director and head of the municipal bond department at StoneX (SNEX).

"People become immune to all the external anxieties that typically create [volatility] in our market. But the market's been fairly orderly, and a lot of these new-issue deals have seen fairly healthy oversubscriptions," Delahunt said.

A $62 million BBB-plus deal for the Milken Community School Project in California that priced Tuesday saw two of its maturities 15 times oversubscribed and bumped 15 basis points, Lando said. "We were interested in seeing how this high-yield charter school deal would perform and what the appetite is like," she said. "Demand is just so much higher than supply, even [with supply hitting] a very record number," she said, adding Thornburg has opted to back off some primary deals and wait until the bonds hit the secondary. "There's so much money coming into munis its hard to keep up with that."

Next week's issuance could rebound to $15 billion to $18 billion.

The bigger impact has been on the rates market, said Jamie Iselin, head of the municipal fixed income team and a senior portfolio manager at Neuberger Berman. The 10-year UST moved from 4% to 4.30% quickly amid fears of higher oil prices and inflation. The muni market entered that period with "tight valuations," so it didn't take much for it to have a slight sell-off, Iselin said. The war in Iran caused a pretty sizable Treasury market backup, which was the "spark" that led to weakness in munis, he said.

The market is facing "rapidly evolving inflation expectations" and a "murkier" interest rate picture, said JB Golden, portfolio manager at Advisors Asset Management. "To date, it is comforting that there does not seem to be any real credit dislocation, and frankly, the fact that we are only a few basis points behind treasuries on the month is reassuring," Golden said. "Most investors seem to be trying to gauge the depth and breadth of the dislocation and at least at present seem to be on the more in the camp [that] the uncertainty will be short-lived."

On the credit side, the transportation sector could come under pressure if oil prices remain elevated, investors said. The price of Brent crude was trading at $106 a barrel Wednesday morning, up from roughly $70 just weeks ago. Credits most exposed to the price pressures include ports, airports and toll roads.

Ports across the country have been in the "crosshairs" since Liberation Day and remain under pressure as of late, said Dora Lee, director of research and partner at Belle Haven. Ports will feel the brunt of the effects of the war in Iran because the economy is already weakening, consumer confidence is on the downtrend and employment levels are showing weakness, Lee said.

While the disruption is mostly on oil, there can be trickle-down effects. Credits that have ongoing large construction projects and those contending with inflation costs could be negatively impacted, Lee said.

Airports and airlines also face strain from higher oil prices, which could lead to higher ticket prices, said Ryan Ciavarelli, Belle Haven's senior vice president for credit research. "If the economy is getting weaker and people are spending more to fill up their tanks, then they're not going to be buying high-price tickets to go on vacation," Ciavarelli said.

In a Friday client note, Barclays (BCS) outlined exposure across the high-grade transportation sector, from airlines to ports, toll roads and mass transit. The firm flagged regional airports and high-yield airlines as currently the most vulnerable, while "in medium-term toll roads, mass transit, ports and even some hospitals and utilities" may be negatively affected.

"Put all together, it feels to us that the [investment-grade] transportation index should have underperformed the broad IG index to some degree, but that has not happened as of yet," Barclays (BCS) said. "We have not [had] oil shocks in quite some time, but if we go back to 2022 and even further out to 2008, the spread differential between the broad IG index and the transportation index widened by a wide margin."

Iselin noted that on the positive side, higher oil prices could generate more revenues for energy-producing states. But if the war in the Middle East persists and leads to a slowdown in overall economic activity, that could be an offset, he added.

Golden said Advisors Asset Management is not avoiding transportation sectors but "over time, it is feasible that it could lead to more of a preference for general obligation debt." Longer-term holdings are more exposed to higher spreads, he said. "Shorter duration holdings as opposed to outright avoidance is, in our opinion, a better course of action."