Municipal Bond News 1/30/23

Fed Urged To Avoid Promising More Rate Hikes… 2023 Best Start For Municipal Bonds Since 2009… Window Closing on Easy Municipal Bond Returns… Municipal Bond New Issues Down 19%…Bankrupt Puerto Rico Utility Deal by April 28…Higher Surplus Boosts Connecticut Reserves… Dismal Returns Compound Pension Woes… Record-High Demand For Chicago Social Bonds…

Fed Urged To Avoid Promising More Rate Hikes…“I don’t think it’s a time to be committing to rate hikes, given the indications of softness that we have seen from a number of quarters,” former Treasury Secretary Lawrence Summers added that the Fed needs to maintain maximum flexibility in an economy that could go either way. While the economy is in an uncertain state with inflation well above the Fed’s 2% target, there are signs of a slowdown. In December, Americans cut spending, and inflation cooled to its slowest pace since October 2021. The U.S. economy grew 1% in the fourth quarter of 2022 compared with a year earlier, down sharply from 5.7% growth in 2021. The slowdown reflects a return to a more normal pace of growth in 2022, following post- COVID-19 business re-openings and fiscal stimulus in 2021.

2023 Best Start For Municipal Bonds since 2009…Investor confidence has grown as the Federal Reserve nears the end of its rate hike cycle. Faced with mounting evidence of a slowdown, investors are seizing higher bond yields before a potential recession, and the rate cuts that eventually follow take them away. January has seen a flurry of cash inflows to bond funds, a sign of higher demand. High yields are a silver lining for those looking to buy municipal bonds. Not wanting to miss out on higher yields, while they last, many investors reckon it is time to buy bonds. January’s 2.8% index returns for municipal bonds is the biggest January return since 2009. The outperformance has pared losses seen last year. With policy rates poised to stabilize this year, 2023 is shaping to be the year to buy tax-free bonds.

Window Closing on Easy Municipal Bond Returns…There has been a steady decline in tax-free yields since October. The drop in bond yields comes after last year’s worst municipal bond rout in four decades. Historically, positive returns have followed negative return years. Volatility is constant theme in financial markets. Easy returns are very likely done, and “investors looking for more yield may need to go to the longer part of the curve, lower coupons or the A-rated and BBB-rated categories,” Bank of America strategists added that while these decisions bear risk, “a combination of all three have produced the best returns over the past three months.”

Municipal Bond New Issues Down 19%…Demand for municipal bonds outweighs supply. States and locals’ bond issuance has dipped to the slowest since 2018. January long-term municipal bond sales are down 19% from a year ago. High interest rates raise the cost of borrowing and diminish opportunities to refinance debt. Massive federal aid post-COVID-19 has boosted government cash coffers, with lesser need for new bond funds. The trend of low supply in the market has continued since 2022. With not enough new bond issuance to replace maturing bonds, the volume of outstanding state and local government bonds decreased in 2022.

Bankrupt Puerto Rico Utility Deal by April 28…Judge Swain has granted a three-month extension for the mediation team to negotiate legacy electric utility debt. There have been no substantive debt talks since December. More time to negotiate comes as the ad hoc group of bondholders is litigating to claim revenue lien granted to bondholders. On Feb 1, Judge Swain will hear arguments on the revenue lien litigation. Revenue lien litigation could open a window for fruitful mediation. Separately, a Fortress Energy subsidiary, Genera PR LLC, has been selected by Island administration to run Puerto Rico’s electric generation. Genera will manage the electric utility’s operating budget, fuel contracts and federal funds. Genera will also be tasked with modernizing the electric grid by eventually replacing the Island’s dozen fossil fuel generation plants with renewable sources. Gov. Pedro Pierluisi said, “Any savings that Genera PR generates will be shared with the government of Puerto Rico and people of Puerto Rico.”

Higher Surplus Boosts Connecticut Reserves…More than $3 billion in rainy day funds this year follow a surge in Connecticut surplus revenue. Connecticut projects an additional $324 million in surplus funds in the current fiscal year. Revenues have outperformed and expenses are down. Governor Ned Lamont attributes the progress to ‘several fiscal guardrails established in 2017’ that he wants to extend. “The era of the permanent fiscal crisis in Connecticut is over,” Lamont said. Cutting debt and building rainy day funds led to ratings upgrades last year, the first in two decades.

Dismal Returns Compound Pension Woes…In 2022, public pension funds lost 6.14%, erasing much of stellar investment returns in 2021. Meanwhile, inflation-adjustments have boosted pension benefits. Missing the mark on return targets, typically about 7%, drives unfunded pension liabilities higher. U.S. state and local government aggregate unfunded pension liability climbed to $1.45 trillion in 2022, a half-a-billion dollars more than 2021 levels per Equable. Funding resources relative to promised retiree benefits fell in 2021. With half of all U.S. states’ funded ratios below 80%, New Yok State’s 94% funded ratio stands tall. Illinois, New Jersey and Connecticut are among U.S. states with lower funded ratios between 50% and 60%. U.S. states have taken steps to address pension funding shortfalls. State contributions to pension plans have trended higher for more than a decade.

Chicago Social Bonds Oversubscribed…The highest amount of retail orders seen in a decade flooded to buy $160 million Chicago Social Bonds issued recently. Strong bids from ESG-focused institutional investors also boosted demand for the new bonds. Strong investor demand led to lower than anticipated yields. Bonds will finance affordable housing. The financing has brought interest rate savings for the recently upgraded city. Chicago CFO said “This pricing is another proof point to follow up on the GO transaction that fiscal discipline saves us money which pays for historic transformative investments” without increasing our debt burden.

Compare 30-Year taxable U.S. Treasury yield 3.65% to 30-Year tax-exempt muni bond yield “AAA” 3.27%; “AA” 3.74%; “A” 4.13%. 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 90% of comparable taxable U.S. Treasuries.