Volatility to Continue to Set the Tone for Public Sector Entities

For the public finance sector, the economic backdrop that set the stage earlier in the year has not changed much – and it’s not likely to do so over the next few months.

“As we look at where we are, through the lens of where we thought we would be at the start of the year, the public finance space is still dealing with many of the same issues, with one of the main ones being ongoing volatility,” said Rob Dailey, head of PNC Public Finance. “Because of the environment, it remains particularly important for institutions to be disciplined in how they bring a transaction to market, whether the bond market or bank market. It’s important that organizations pay close attention to all the variables and stay nimble, and this is likely to remain especially important for a longer period of time than we may have anticipated.”

A Stubborn Inverted Yield Curve

As the Federal Reserve continues its battle to curb inflation, it has yet to signal when it will lower interest rates, contrary to many expectations at the start of the year. This has resulted in a prolonged inverted yield curve, and while it may show signs of flattening in the year, in PNC’s view it is not likely to a achieve a more positive slope until 2025. When it does normalize and short-term rates are again lower than long-term rates, this will create opportunities for organizations to optimize their exposure to interest rates and save money. Borrowers and investors have the opportunity now to plan for when that happens, in terms of thinking about when to schedule debt payments, at what point on the curve to invest, and the role of floating rate exposure.

Liquidity Challenges in the Bond Market

There are a number of factors creating pressure on liquidity in the bond market, including the withdrawal of several significant dealers from the market earlier this year and tighter federal regulation for bond broker dealers of municipal bonds. That said, the market has performed well as issuance has increased, now running approximately 25% higher than last year. The municipal bond market is increasingly aligning with the processes and standards of the larger taxable markets, and the immediate effect is that many investors value larger bond issues and maturities more highly due to greater liquidity, which may drive structuring decisions for issuers. Issuers may need to place greater emphasis on liquidity upon issuance and focus on the size of deals in the primary market and size of individual maturities upon issuance in the secondary market. The current environment also reinforces the importance of working with a reliable bank that can help with quality deal execution.

Financing for Government Entities

Over the past two years or so, the need for financing for government entities in the public finance space has slowed somewhat, due largely to the amount of funds available in the economy through federal stimulus. We are seeing the effect of this beginning to recede, and we expect the trend to build through the latter half of this year. Given that some federal government support will remain available through 2026, this will likely be a longer-term dynamic that plays out over the course of a couple of years. As federal support for infrastructure subsides, government entities will need to turn to other solutions to provide their own financing.

Cybersecurity Risk

Volatility is not limited to the financial markets. In addition to contending with risk and uncertainty stemming from a number of fronts, including the actions of the Fed, geopolitical tensions, and impacts from the upcoming presidential election, it’s important for organizations not to lose sight of another type of threat that is closer to home: cybersecurity and fraud. Public sector entities remain a target for cybersecurity breaches by both networks of cyber criminals and nation state actors, capable of evading detection and staging extremely sophisticated attacks. Given the magnitude of the threat, it is more important than ever to both shore up vulnerabilities and proactively address cybersecurity risk. This requires informed decisioning and preparation for resilience and reconstitution in the face of a bevy of possible scenarios.

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