Municipal Bond News 1/13/25

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Muni Bond Yields Highest in a Year…Federal Spending on Chopping Block…Wall Street Divided Over Rate Cut Odds… FEMA To Mitigate Wildfire Damage…New Tolls Boost MTA Capital Plans…SALT Talks ‘Positive’…California Budget Plan…U.S. States Weigh Federal Funding…

Muni Bond Yields Highest In A Year…Muni bond yields are the highest in a year. Taxable equivalent yields of muni bonds are as high as 7% to 8%, depending on federal tax bracket, credit and maturity. Last week, yields on state and local government bonds increased by 15 basis points, following a similar rise in U.S. Treasury yields. Long term U.S Treasury yields topped 5% last week, the highest since November 2023. The 5% Treasury yield level has only been breached a handful of times over the past decade. Treasury yields have climbed about 100 basis points since the Fed started cutting rates last September. Robust jobs growth in December contributed to the higher bond yields. Consumers’ long-term inflation expectations jumped to the highest since 2008 on concerns about potential tariffs from the Trump administration. In December, Fed officials saw risks of higher than expected inflation, partly owing to potential tariffs, minutes of the Fed meeting suggest. The surge in bond yields has lured investors to invest cash into muni bonds.

Federal Spending on Chopping Block…A “menu” of $5.7 trillion in federal spending cuts has been floated by House Republicans. Changes to Medicaid, ending Biden administration climate programs, slashing welfare programs and “reimagining” the Affordable Care Act are in the early list of potential spending cuts. Additionally, the document floats clawing back bipartisan infrastructure and Inflation Reduction Act funding. However, such cuts are likely to face opposition from Democrats and some Republicans. Given Republicans’ narrow majority in the House and Senate, it remains uncertain how many of these cuts will actually be implemented.

Wall Street Divided Over Rate Cut Odds…Bank of America Corp., Citigroup Inc. and Goldman Sachs have pared back their forecasts for additional Federal Reserve interest-rate cuts. Bank of America no longer expects any rate cuts this year, noting that rate hikes could be reconsidered if inflation drifts higher. Citigroup is still looking for five quarter-point cuts, but has pushed back the timeline, now predicting they will begin in May, later than previously expected. Meanwhile, Goldman Sachs predict rate cuts in June and December, and in June 2026. Bond markets assign higher odds to about 30 basis points rate cut in 2025, with the first rate cut anticipated in September.

FEMA To Mitigate Wildfire Damage…Revenue disruptions bring operational risks to electric, water and sewer utilities, schools and other assets in a vast wildfire spanning almost 28,000 acres in the Los Angeles area. Typically, governments must tap into their own funds to immediately respond to disasters, but they can expect to receive FEMA money to recoup those costs. FEMA aid and insurance payments will help with rebuilding disaster-struck areas. Damages and economic losses from the wildfire are estimated above $150 billion, making it one of the costliest natural disasters in U.S. history. A California budget official noted that in previous years when local governments were hit by reduced taxes from the loss of homes and the consequent reduction in assessed property values, lawmakers have provided funding to cities to compensate for the shortfall, subject to lawmakers’ discretion as budget talks move forward. Moody’s said, “It is too early to evaluate potential impacts to property valuations or other credit implications for individual local governments.” Amid downgrade risks, the yield penalty for power utility bonds issued by the nation second largest city surged. Los Angeles Department of Power and Water is set to offer $371 million high grade water bonds this week.

New Tolls Boost MTA Capital Plans…On January 5, 2025, New York City became the first U.S. city to introduce congestion tolls. The new tolls will allow MTA to make critical capital investments, without a significant increase in debt. MTA expects to raise $15 billions of financing over a longer period than initially planned. If successful, the new tolling program will gradually increase transit ridership. A federal judge recently ruled against a lawsuit brought by State of New Jersey which sought to halt congestion pricing. However, the ruling required the Federal Highway Administration to provide additional information on the environmental impact on certain communities by Jan. 17. Based on President -elect Trump’s opposition to congestion tolls, future political support for this new initiative remains unclear.

SALT Talks ‘Positive’…16 House Republicans unhappy with a $10,000 cap on state and local tax (‘SALT’) deductions said they had “positive” talks with President-elect Trump over the weekend. Republican lawmakers in high tax states want to see the cap raised or eliminated to soften the burden on property owners in states like New York and California. 34 U.S. states have enacted workarounds to the SALT cap. Significant expansion of the SALT deduction cap is emerging as a potential demand by some Republicans, in return for supporting any larger tax-related package. The first 100 days of the Trump administration will bring important tax policy and debt ceiling legislation.

U.S. States Weigh Federal Funding…U.S. states are beginning the 2026 legislative sessions without clarity on what federal funding will look like. Federal funding for Medicaid is a key concern regarding how the incoming Trump administration will affect state budgets. “We are doing the best that we can to try to predict the things that might happen,” Illinois Governor Pritzker (D) said he’s weighing the possibility that potential changes “will create another hole in the budget.”

California Budget Plan…Governor Newsom presented a $322 billion budget plan for Fiscal 2026 last week. Outperforming tax revenues bring a $363 million surplus to the Golden State. The spending plan includes a $16.9 billion reserve and no tax hikes. The budget makes very few new spending commitments, and boosts funding to rainy day funds and a special fund for economic uncertainties such as natural disasters. California State Treasurer noted “I look forward to the May Revise when we will have a fuller picture of the state’s finances and know the full extent of damage from the devastating fires in the Los Angeles area.”

Compare 30-Year taxable U.S. Treasury yield 4.94% to 30-Year tax-exempt Municipal Bond yield “AAA” 4.01% “AA” 4.33%; “A” 4.42%. For investors in the 35% tax bracket, a 4% tax-exempt yield is equivalent to a 6.15% taxable yield. Top-rated long-term tax-free bonds yield 81% of comparable taxable U.S.  Treasuries