Zika could bite municipal bond market

Loop Capital suggests that municipal bonds may see a fallout from the Zika virus. Municipal bonds could offer insight into deeper economic impacts as the spread of the disease is associated with dense urban transport centres, therefore, the economies of large issuers of municipal debt - such as large cities in the south-east of the US - are likely to be impacted. The fear of Zika can also reportedly lead to an "altering economic behaviour," reducing retail sales, tourism and weakening local economies. Furthermore, this could translate to falling bond prices and rising yields on any new issuance for those areas, and put pressure on prices of related bonds already in circulation. As we noted earlier this week, scientists have uncovered the first reliable evidence that Aedes aegypti mosquitoes carry the Zika virus, a crucial breakthrough in trying to eradicate that species; now a new report suggests that the case rate of microcephaly in unborn children could be as high as 13% for mothers infected with Zika in the first trimester.

As U.S. officials race to prevent an outbreak of the Zika virus, financial markets are beginning to feel the bite.

Municipal bonds — a relatively quiet corner of the financial universe but a potential lens on deeper economic impact — could see fallout from a spread of the virus, according to a report by Loop Capital released this week. There’s already some history for reference — devastation from Hurricane Katrina had a notable impact on regional finances and beyond.

Zika can cause severe birth defects in the brains of fetuses. Those include microcephaly. Mosquitoes carrying Zika are expected to spread to the U.S. in the next “month or so,” the government’s top infectious disease expert said Sunday.

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Because the spread of Zika is associated with dense urban-transportation centers, the virus likely would hurt the economies of large issuers of municipal debt, mainly big cities in the South East, according to the report.

Loop Capital makes the case that fear of Zika can result in “altering economic behavior”— such as reducing tourism and retail-sales revenue, severely weakening the local economies and public revenues of affected areas. It’s those revenues that fund bond payments.

Read: This state-of-the-art Zika virus test is also really, really cheap

See also:Your dream of a world without mosquitoes is one step closer to coming true

The sentiment change could translate into falling bond prices on any new issuance for those cities and rising yields, which move inversely to prices. And it might pressure prices on related bonds already in circulation.

Flagging appetite for municipal bonds, which are sold by U.S. state and local governments and are coveted for their relatively steady performance, could result in wider yield spreads for muni bonds linked to Zika regions. Spreads tend to widen when investors perceive a higher risk in certain bonds than others and require higher compensation, by way of yields, to hold those securities.

“Tourist-related activity will be negatively impacted. Both business and leisure travelers from the U.S. and Europe may respond to travel advisories, particularly if aimed at the threat to pregnant women, or those planning a pregnancy,” noted Chris Mier, chief economist at Loop Capital.

“Retail activity could also be impacted if consumers avoid the more densely populated commercial centers,” he said.

The National Center for Atmospheric Research has analyzed Zika risk levels for U.S. cities, as the following map shows:

The Southern Office of the Council of State Governments

Loop analysts overlapped the above map with the below ranking of states based on public-health expenditures.

These are the states with above-average per-capita spending for public health:

Loop Capital

And these are the states with below-average per-capita spending for public health:

Loop Capital

The results showed that nine states — most notably Florida, Louisiana, Mississippi and Texas — fall below the national average in public-health spending and are in areas with high-risk of Zika. Those states could see municipal-bond prices tumble, and yields or the costs of borrowing push higher, according to the report.

In the past, the general success with which the U.S. had countered public-health threats created some complacency in the market and a jaded perspective on epidemics.

“The conventional wisdom was that the federal money spigot opens quickly, amply and directly to supply communities with needed funds,” Mier said.

But that euphoria ended with Hurricane Katrina.

Prior to Katrina, the municipal market presumptively believed that federal and state health and safety authorities — FEMA, Public Health departments, etc. — would help alleviate the financial difficulties of cities or states, so natural disasters and other public-health threats did not really influence the price of the bonds of the affected municipal governments, the report said.

But in 2009, a report on the effects of natural disasters on municipal-bond pricing showed that California communities with high seismic risk assessments started seeing wider spreads or yield differentials to benchmark Treasury yields after Katrina — which was not evident before Katrina.

What the report on the California communities’ bonds showed was that before Katrina municipal investors thought that differentials in seismic-risk evaluation didn’t matter much, because state and federal support was a certainty.

After Katrina’s botched disaster-relief efforts, the market for California bonds began to demonstrate wider spreads than those with lower seismic-risk scores.

“Investors may now apply that lesson to other disaster situations, including the Zika epidemic,” Mier said. “As was the case with Katrina, it has the potential to provide adverse surprises for analysts with respect to the effectiveness of the federal, state, and local government response.”