Municipal Bond News 1/23/23

Long-Term Municipal Bonds Outperform…High Yield Tax-Free Bonds Rally…Signs of A Slower Economy…Fed Officials ‘Stay the Course’…Mayor Lightfoot Faces Tough Election…PREPA Debt Court Hearing…U.S. States’ Record-High Reserves…Multi-State Coalition Seeks Progressive Taxes…

Long-Term Municipal Bonds Outperform…This year, top-rated long-term municipal bond yields have dropped about 35 basis points. The Federal Reserve’s actions are beginning to reign in price levels. Signs of slower economic growth have raised recession odds. Investors have boosted investments in the $4 trillion tax-free bond sector. In January, weekly inflows to municipal bond funds reached their highest in more than a year. Higher demand for tax-free bonds this year suggests that the year-long rout in bond markets, driven by Fed’s rate hikes, is easing. Recognizing signs that inflation may have peaked last year, long-term municipal bonds are most favored by investors, as are high- yield tax-free bonds. Long-term municipal bonds have gained 4.8% this month, outperforming overall municipal bond 2.8% index return.

High Yield Tax-Free Bonds Rally…Leading the municipal bond rally in 2023, widely- held high-yield municipal bonds such as tobacco and Puerto Rico bonds have notched sharp gains close to 8% in January. This year, investors are seeking bonds issued by junk-rated or non-rated bond issuers. The shift comes after investors pulled out $21 billion from high yield municipal bond funds in 2022. Low supply is also a factor. As an example, there were no tobacco bonds issued last year. The lack of tax-free bond issuance is most stark for high-yield municipal bond issuers, who often face steep interest costs in a high-rate environment.

Signs of A Slower Economy…Amid dismal holiday shopping, retail spending in December fell at the sharpest pace in December. Purchases at stores, online and restaurants dropped 1.1% in December from a month ago, after dropping 1% in November. A steep drop in industrial production has followed suit. Industrial production, a bellwether for manufacturing activity, fell 0.7% in December, following a similar drop in November. In a tumultuous year for the housing market, 5 million existing homes were sold in 2022, a drop of almost 18% from 2021, the biggest annual slide since 2008. A gauge of wholesale prices, the producer price index dropped 0.5% in December, more than the 0.1% dip expected. Supply chain-related price pressures were largely resolved in 2022. Weaker demand has led to lower prices.

Fed Officials ‘Stay the Course’…“Even with the recent moderation, inflation remains high, and policy will need to be sufficiently restrictive for some time to make sure inflation. returns to 2% on a sustained basis,” Fed Vice Chair Lael Brainard. Some voting fed officials support slowing the pace of rate hikes, while supporting further tightening. Voting fed official Philadelphia Fed president Patrick Harker said that the ‘days of us raising rates by 75 basis points at a time have surely passed’ adding that he favors ‘hikes of 25 basis points will be appropriate going forward.”

Mayor Lightfoot Faces Tough Election…A two-person run-off election in April is likely to decide the outcome of Chicago’s Mayoral election. With nine contenders for Chicago’s top office, it is unlikely that any one candidate will win an outright 50%+ majority on the February 28 election. Mayor Lightfoot’s reelection bid is challenged by political stalwarts including Rep. Jesús “Chuy” García (D), former Chicago Public Schools CEO Paul Vallas, Cook County Commissioner Brandon Johnson (D) and state Rep. Kam Buckner (D), Alds. Sophia King and Roderick Sawyer, activist Ja’Mal Green and businessman Willie Wilson. The incumbent advantage is with Lightfoot, but her campaign is outspending its funding resources. Should Lightfoot make it to the run-off, she faces tough competition from Garcia and/or Vallas among others.

PREPA Debt Court Hearing…On February 1, Judge Swain will hear arguments on how much electric utility revenue is pledged for legacy revenue bond repayment. Bondholders oppose the oversight board’s argument that PREPA bondholders only have a claim to trust accounts holding about $16 million. Bondholders claim they are entitled to the electric utility’s future revenue as well. The oversight board proposes splitting bondholders into two groups: one that would drop their claims on PREPA revenue and settle; while a second group that could continue the revenue lien litigation. Separately, the board and Island administration have approved a private operator to run the Island’s electric generation system. The latest move towards the utility’s privatization comes after Luma Energy took charge of electric transmission and distribution in 2021.

U.S. States’ Record-High Reserves…Rainy day funds, along with other general fund surpluses, for U.S. states could top $280 billion in 2023, more than double pre-pandemic levels, a state budget officers estimate. 50 U.S. states’ aggregate reserves climbed to $136 billion at the end of 2022, from $80 billion in 2019, per S&P data. Many states’ revenue collections continue to outpace forecasts. For example, New York State collected $7.7 billion more in taxes than forecast for the first nine months of Fiscal 23. “Tax collections continued to exceed projections through December,” New York State comptroller added “However, concerns of an economic downturn and a cloudy revenue picture continue to create uncertainty.” California expects a budget deficit in Fiscal 24. Faced with recession forecasts in 2023, U.S. states have flat-lined or lowered spending, a change from heady revenue outperformance a year ago.

Multi-State Coalition Seeks Progressive Taxes…Eight U.S. states introduced tax-the-rich bills on one day last week. Vexed by wealthy outmigration from high tax areas, lawmakers appear to be taking a coordinated approach to tax hikes. “Let’s make sure if they move, they have nowhere else to go because we’re all taxing them together,” a Washington state lawmaker said. California, Illinois, New York, and Washington, are looking at a new set of wealth taxes, while bills in New York, Hawaii, Maryland, Connecticut, and Minnesota seek to raise taxes on realized income. Notably, an Illinois bill seeks taxpayers to annually recognize gains in asset values as income, to be taxed at Illinois’ flat rate of 4.95%. An array of plans seeking higher taxes on wealth, capital gains, estates and income are making their way in state capitols. Varying state constitutions will be a factor.

Compare 30-Year taxable U.S. Treasury yield 3.68% to 30-Year tax-exempt muni bond yield “AAA” 3.22%; “AA” 3.76%; “A” 4.16%. 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 88% of comparable taxable U.S. Treasuries.