Municipal Bond News 1/9/23

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Municipal Bond Market 2023 Outlook … HNW Individuals Dominate Municipal Bond Demand… Fed to Hold Rates High…Infrastructure’s Money Flood…Puerto Rico Revenue…Decade-High Pension Contributions…Casinos in New York, Chicago…

Municipal Bond Market 2023 Outlook …As investors begin to look to the other side of the Federal Reserve’s tightening cycle, municipal bonds look underpriced. A shrinking municipal bond market, a decline in U.S. Treasury bond yields amid optimism that inflation may have peaked augurs well for the $4 trillion municipal bond sector. The municipal bond market shrunk in 2022. The value of outstanding municipal bonds declined by 4.3% in the third quarter of 2022. Municipal bonds are maturing faster than new ones are issued. In 2022, states and locals issued 23% fewer municipal bonds than a year ago. Last year, municipal bond indices outperformed taxable Treasury bonds and corporate bonds. The municipal bond sector suffered its worst losses in 2022, as investors sold $145 billion of mutual funds. However, losses pared in November and December upon a slowdown in the pace of federal-funds rate hikes. In 2022, municipal bond yields peaked in October with about 4.18% yield for long-term top-rated tax-free benchmarks. Surging retail demand and narrower mutual fund redemptions have pushed yields lower in recent months. Municipal bond prices are still attractive, with tax-free yields about 94% of comparable taxable Treasury yields. Although bond prices could be volatile, wealthy long-term investors look beyond paper losses to locking in higher tax-free yields for reliable tax-free income while yields are still high. When the Fed finally pivots monetary policy, municipal bond prices stand to appreciate.

High Net Worth Individuals Dominate Municipal Bond Demand…Many investors booked tax losses in 2022 by selling municipal mutual funds and are switching to holding individual municipal bonds. Higher yields of state and local government bonds have boosted demand from High Net Worth (‘HNW’) individuals, who are buying municipal bonds at a rate of roughly 4-to-1 versus institutional investors, a brokerage firm noted. This shows a significant uptick in retail investor demand for municipal bonds. A Municipal Bond Specialist’s expertise helps wealthy investors buy individual tax-free bonds at value prices, with informed credit research. Before the Great Recession, almost 70% of municipal bonds were rated ‘AAA’, the majority carried bond insurance. Today, less than 16% of municipal bonds are ‘AAA’-rated, and fewer municipal bonds are insured. Credit research helps uncover some unique investment opportunities for diversified tax-free portfolios. A Municipal Bond Specialist’s bond inventory allows retail investors to access a wide range of sectors, states, ratings and maturities in the $4 trillion municipal bond market made up of tens of thousands of issuers.

Fed To Hold Rates High in 2023… Most Fed officials expect to raise rates higher than 5% in 2023 and hold it there until sometime in 2024. Rate cuts in 2023 are not on the table, Fed Minutes released last week suggest. However, bond markets differ. Fed-funds futures markets anticipate rate cuts by year-end, with target fed-funds rate hitting a plateau of 4.75%-5% by mid-year, up from 4.25%-4.5% currently. That could imply roughly 25 basis point rate hikes are likely in Feb-23 and March-23. The effects of aggressive Federal Reserve rate hikes in 2022 are beginning to take effect. Inflation moderated in October and November. December wage gains were below expectations and prior months amid strong jobs growth. Fed officials are looking for ‘substantially more evidence of progress to be confident that inflation was on a sustained downward path.’ Investors’ growing confidence that inflation could fall in 2023 has the Federal Reserve worried that markets might underestimate the central bank’s resolve to hold interest rates at higher levels.

Infrastructure’s Money Flood…2023 brings more infrastructure spending, continuing an uptrend that began last year. The $1.2 trillion Infrastructure Investment and Jobs Act, the $740 billion Inflation Reduction Act, the $280 billion CHIPS and Science Act, and about $60 billion of new November 2022 bond measures for capital projects make way for capital upgrades in 2023. “Everybody got some kind of money: energy, transmission, water, wastewater, roads; there’s a lot of new funding coming through,” However, the money will not go as far because material and labor cost spikes. 75% of the nation’s infrastructure is funded by states and local governments. As Republicans gain a narrow majority in the House, they will control key committees like Transportation & Infrastructure. However, this cannot interrupt the flow of the federal infrastructure dollars, set to support the sector through 2026. Revenue from infrastructure projects that may secure municipal bonds are often inflation-indexed. Capital upgrades, without incurring new debt, are broadly favorable for tax-free bond issuers.

Puerto Rico Revenue…Puerto Rico tax collections in the first four months of Fiscal 23 are 8% higher than projected, and 2.4% lower than prior year. The largest haul came from income taxes paid by corporations and individuals. The labor market is still growing, a clear positive indicator of the effects of the income tax credit implemented in 2022 and the increase of the minimum wage,” Inteligencia Econimica reckoned “Even though inflation is still high, consumers are showing some kind of resiliency to keep buying cars and other durable goods.” Despite Hurricane Fiona, September and October tax collections came in 12% higher than projected.

Decade-High Pension Contributions…States and local governments’ overall contributions to public pension plans have climbed to a twenty-year high. Since the Great Recession, governments have ramped up pension contributions. “We’ve seen what can only be characterized as a surge in state and local contributions starting in 2014 or 2015,” a NASRO researcher stated “We’ve been impressed by the magnitude of the effort to improvement contributions, especially among states that have had a lot of trouble doing so in recent years.” Many states including Connecticut, Hawaii and New Jersey used budget surpluses for supplemental pension contribution. Despite the promising aggregate contribution levels, contribution levels vary widely for states and local governments. Employer contributions make up three-quarters of public pension contributions.

Casinos in New York, Chicago…“This is a major, major milestone in our city,” Mayor Lightfoot welcomed Chicago City Council approval of Bally’s to operate Chicago’s sole casino. Chicago Bally’s $1.7 billion casino development is slated to eventually bring $400 million annually, to be split between the city and state. Three new casinos in New York City are planned. By mid-2023, a state committee will likely select a development plan. Real estate developers and top casino companies have submitted large-scale plans spanning Hudson Yards to the East River. New York State legalized online gambling in 2022, leading to $500 million of additional state revenue. Casino taxes will help plug projected New York State budget deficits.

Compare 30-Year taxable U.S. Treasury yield 3.71% to 30-Year tax-exempt muni bond yield “AAA” 3.55%; “AA” 3.88%; “A” 4.53%. 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 96% of comparable taxable