Municipal bond market endures first real liquidity test post-Citi exit

When Citi left the municipal bond space in December 2023, many market participants warned that the true test of the firm’s exit would not come until a time of significant market volatility.

That test came last week. With yields bouncing around by nearly 100 basis points over a few days, Citi’s traditional role as one of the top go-to liquidity providers was sorely missed, several buysiders said.

At the same time, even the presence of a leader like Citi would likely not have made much of a difference amid wild price moves, which convulsed all markets, muni investors said.

John Mousseau, vice chairman and chief investment officer at Cumberland Advisors, was among the market participants in late 2023 predicting that Citi’s exit would be felt most acutely during liquidity crunches.

“And boy, that’s exactly what happened,” Mousseau said.

“Citi was hugely capitalized on a relative basis and would have had some leadership role in times of stress, and this was one of those times,” he said. “They would have stepped in and used their balance sheet and buy some bonds and steady the market.”

Citi’s leadership in buying bonds would also have sparked other broker-dealers to follow, Mousseau said. “And when other dealers see someone like Citi, who’s a good leader, they themselves will step up to the plate,” he said. “It’s a question of who’s the first person going into the ocean.”

In anticipation of President Donald Trump’s sweeping new tariffs policy, munis sold off Monday, April 7, and Tuesday, April 8, with weakness exacerbated by record exchange-traded fund outflows. Muni yields continued to rise even higher last Wednesday as a midday announcement from Trump about a 90-day extension on most tariffs could not reverse the damage.

Munis then rallied on Thursday, erasing all of Wednesday’s losses and then some, but come Friday, munis sold off once more. So far this week, munis have been seeing gains through Wednesday, with Monday seeing the greatest bump in yields, as the market finds some stability as things settle down.

“It’s hard to draw a direct line to Citi’s departure but it certainly doesn’t help that Citi is not in the market — clearly their lack of presence in the market has a negative impact from a liquidity perspective,” said Nick Venditti, senior portfolio manager and head of the municipal fixed income team at Allspring Global Investments. “But I think last week the market got so bumpy that Citi wouldn’t have helped one way or another,” he added.

Mousseau and Venditti noted that as the market cheapened, nontraditional buyers stepped in and provided liquidity.

“Munis backed up so aggressively that the Muni/Treasury ratios started to look significantly more attractive, and we started to see crossover buyers come into the market and that helped set a floor,” Venditti said. “We ended up gathering excess liquidity from nontraditional buyers,” he said, like insurance companies, hedge funds and traditional taxable mutual funds.

“The broker-dealers stepped back a little bit because they don’t want to put risks on their balance sheets in periods of insane market volatility,” he said.

The lack of capital among muni broker-dealers is part of the market’s wider liquidity problem, buysiders said.

“My concern is not that Citi is gone; it’s that there just is not enough capital compared to 15 years ago anyway, and you have a growing market,” said John Flahive, head of fixed income at BNY Wealth.

“From talking to broker- dealers last week, there were some that were afraid that the amount of potential losses on some of the trading desks was so large that their risk would be at least pulled back a little bit,” he said. “So it’s not that Citi left, it’s that who is left in times of stress like this may be asked to pull back.”

There’s a finite amount of capital with these broker-dealers, he said. And if there are other asset classes that historically have made them more money in times of stress, like high-yield or the floating market, that capital would probably not go to municipals, Flahive noted.

Even without Citi, there are plenty of broker-dealers and plenty of capacity, he said.

“Are they using it? Some are, some not, and we haven’t seen the dust settle on how difficult it was on their P&Ls because of the inability to effectively hedge it, which has always been a weakness of municipals,” Flahive said.

The paring back among firms and trading desks also hurts the market in volatile times, Mousseau said. In addition to Citi, UBS left the negotiated market and “with other firms, we’ve seen a cutback in sales, so at the margins you’ve seen a reduction in personnel at the desk, which means it’s that much harder to get stuff done.”

Mark Paris, chief investment officer and head of municipals at Invesco, said he believes the muni market overall managed well through what was the first real test of big market moves without a firm like Citi.

“There’s one less big dealer in the marketplace. The muni market has done a really nice job of covering for that,” Paris said. “And other places have stepped up. Big shops that have done a nice job. More smaller shops have expanded what’s going on.”

Citi’s role as liquidity provider in the market had changed over the years before its exit, noted Dan Solender, partner and director of tax free fixed income at Lord Abbett.

“The market has had reasonable liquidity at adjusted prices and did not really miss Citi’s presence the way it had been participating the past 10 years or so before they shutdown their muni department,” Solender said in an email. “Many of their traders have moved to other firms so they were able to participate from new locations,” he said.

But “if you compare things to Citi’s level of participation prior to the 2008 credit crisis, then there has been a material impact because at that time they held more inventory and took more risk,” he said.