U.S. cities and states are leery of borrowing more money despite near-record low interest rates, forcing bond funds to scour for investments and boosting returns on existing debt.
The drought in bond issues is also slowing city and state capital projects and threatens to disrupt the summer high season for bond buying.
So far this year, sales are running 25.4 percent below the same period in 2013, according to preliminary Thomson Reuters data. May's issuance, $22.41 billion of bonds sold in 907 deals, was the lowest for the month in three years and the smallest since January, when only $18.17 billion in bonds came to market.
The paltry pace has investors competing to get a slice of new deals and in many cases forcing them to bid on lower-quality credits than they would like.
"Many of the new issues that are coming to market are eight to 10 times oversubscribed. So it's difficult getting bonds," said Burton Mulford, portfolio manager at Eagle Asset Management, which emphasizes high-grade debt.
Eagle has begun buying more single-A credits, the mid-to-low end of the investment-grade scale. Instead of focusing on deals of at least $75 million, it has been looking at some $35 million and $40 million deals, Mulford said.
The city and state refinancing binge, which was fueled by low interest rates, ended in 2013 as rates rose and retail buyers avoided the municipal market, spooked by bad financial news from Detroit and Puerto Rico. Issuance started falling.
As 2014 dawned, many expected bond sales to drop further, given that governments' financial managers are gun-shy about taking out debt after the budget crises resulting from the 2007-09 recession. Political leaders facing elections in November, too, may want to appear conservative about borrowing.
Last year's 0.4 percent growth in municipal bond sales was the smallest in 20 years, and the trend is set to continue "because of the slow and uneven pace of revenue recovery," according to Moody's Investors Service.