Municipal Bond News 1/21/25

Muni Bonds’ Yield Advantage…Vibrant Primary Muni Bond Offerings…Fed Officials Weigh Sooner Rate Cuts…Chicago Downgraded…Busy Airports Eye Bond Sales…Chicago Public School Finances Must Improve…Muni Market Weighs Wildfire Impact…Can U.S States Afford Tax Cuts…

Muni Bonds’ Yield Advantage…Municipal bonds (munis) are currently underperforming a U.S. Treasury rally. This presents an opportunity to lock in tax-free yield, currently at a12-month high. As financial markets reset expectations on rate cuts, muni bond yields were roughly unchanged or slightly higher from a week ago. In contrast, U.S. Treasury yields dropped 15 basis points amid growing bets for the Fed to cut rates sooner. U.S. consumer prices rose less than forecast in December. Treasuries rallied after President Trump opted for no China-specific tariffs at this time. The underperformance of muni bonds during last week’s Treasury rally can be partly attributed to a significant number of new offerings in the primary market.

Vibrant Primary Muni Bond Offerings…A robust mix of mega muni bonds were sold last week. MTA’s new bonds issued by Triborough Bridge and Tunnel Authority were upsized to $1.6 billion. The new bonds secured by New York City real estate transfer taxes, rated S&P ‘A1’ Moody’s ‘A+’, fetched a top yield of 4.58%. San Francisco airport issued $984 million bonds fetched a top yield of 4.6%. Orlando Health Obligated Group issued $1.2 billion bonds rated S&P ‘A+’ Fitch ‘AA-’ at a top yield of 4.6%. Looking ahead, close to $10 billion new muni bonds are expected to be sold this week.

Fed Officials Weigh Sooner Rate Cuts…A chorus of Federal Reserve officials have welcomed December’s favorable inflation report. “If we continue getting numbers like this, it’s reasonable to think rate cuts could happen in the first half of the year,” Federal Reserve Governor Christopher Waller added that he wouldn’t entirely rule out a cut in March, and three or four rate cuts this year are possible, depending on incoming data. New York Fed President John Williams noted, “The process of disinflation remains in train. But we are still not at our 2% goal, and it will take more time until we can achieve that on a sustained basis.” Bond markets assign higher odds of the Fed’s first rate cut in July.

Chicago Downgraded…S&P downgraded Chicago’s general obligation bond rating to ‘BBB’ from ‘BBB+’ last week, and assigned a stable outlook. A persistent structural imbalance and a difficult 2025 budget process were cited as reasons for the downgrade. In response, the mayor’s office said, “The city’s credit fundamentals have not changed, and the rating does not accurately reflect the strength of the city’s credit or ability to meet its debt and pension obligations.” Notably, S&P gave Chicago credit for preserving the supplemental pension payment in the 2025 budget. The end of COVID-19 relief funds and the city’s underfunded pensions are challenges. Chicago’s overall reserves and liquidity remain strong enough to support a stable S&P outlook.

Busy Airports Eye Bond Sales…San Francisco, Denver and Dallas Fort Worth airports are readying big bond sales in 2025. Air travel continues to surge past pandemic levels. Many airports, including New York City airports, are bracing for record-breaking passenger volume in 2025. Large muni bonds sales by airports are expected to continue in 2025. “With a need to fund upgrades (partly to accommodate larger aircraft) and lower interest rates, most airports whose debt we rate will increase issuance for capital projects,” Moody’s noted, adding “However, increased issuance will not weaken most airports’ credit quality, buttressed by robust liquidity and an ability to recover debt service costs through hikes in airline rates and charges.”

Chicago Public School Finances Must Improve…The Civic Foundation, a non-partisan watchdog, said that Chicago Public Schools’ (‘CPS’) budget for this year is “structurally imbalanced.” “The amount of money we’re talking about involves a deficit of well north of $750 million, may be as much as a billion dollars,” Civic Federation President noted. The budget does not account for the cost of a future contract with the Chicago Teachers Union, which is still being negotiated. Over the past decade, the district’s budget has grown by more than 50% from $6.4 billion in 2016 to $9.9 billion this year. However, enrollment has declined and significant staffing expansions were funded partly by federal pandemic aid. The Civic Federation recommends higher property taxes, rightsizing staffing, and seeking state support.

Muni Market Assesses Wildfire Impact…Unfavorable rating actions for the City of Los Angeles and its largest power utility have followed the wildfires. Legal liabilities for utilities and revenue losses are possible from disruptions caused by the wildfires. Fire-affected areas have approx. $70 billion of outstanding muni bonds per Bloomberg. Such bonds are currently seeing higher yields. “There will be an ‘LA penalty’ and there will be some widening on the state’s debt,” a portfolio manager told Bond Buyer, “Be Warren Buffet in times of crisis. Take advantage of those who panic. Spreads will widen – buy the dip.” The large size of Los Angeles County and the city contributes to its resilience. The State of California is likely to face a delay in income tax receipts. Governor Newsom has proposed a $2.5 billion recovery package. However, the impact of the wildfires on state finances is likely manageable given the Golden State’s strong liquidity. Historically, the broader muni bond market has been resilient to past natural disasters.

Can U.S States Afford Tax Cuts… “Overall, states are experiencing tighter budget conditions,” the National Association of State Budget Officers noted recently. In the first five months of the budget year in most states, (July to November) total state tax revenues declined by 0.6%, per the nonprofit Urban Institute. In light of “weak” revenues, “states should pause and stop cutting taxes,” an Urban Institute expert noted. Since 2021, more than half the states have reduced personal income tax, property tax or statewide sales tax. As Congress considers President Trump’s agenda of tax cuts and lower federal spending, state legislatures are beginning to evaluate whether they can afford to lower state taxes. Unlike the federal government, which can run a deficit, states are required to adopt balanced budgets.

Compare 30-Year taxable U.S. Treasury yield 4.80% to 30-Year tax-exempt Municipal Bond yield “AAA” 4.05% “AA” 4.30%; “A” 4.46%. 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 84% of comparable taxable U.S. Treasuries.