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Municipal Yields Calmer Amid Treasuries Sell-off…In October, the municipal bond market gained 0.86% per benchmark index returns, while United States Treasury bonds have been pummeled with a 1.44% loss. Last week, U.S. Treasury bond yields climbed about 10 basis points, relative to a smaller 4 basis point yield surge for tax-free bonds issued by states and local governments. Municipal bonds’ outperformance relative to taxable Treasuries comes as states and local governments are issuing fewer municipal bonds this year. “Retail investors, on the other hand, appear to appreciate current higher tax -exempt yield levels and view munis as an area with lower volatility relative to taxable bond or the equity markets,” Bank of America strategists noted. Tax-free mutual funds have seen vast redemptions this year, and the lower new issue bond supply is a partial offset.
Steeper Rate Hikes Ahead…Near certain odds of a fourth 75-basis point rate hike in November and a growing possibility of a similar-sized rate hike in December come on the heels of higher-than-expected inflation. Rate hikes could slow to a half-point rate hike at the first Fed meeting of 2023 in February. Markets expect the fed-funds rate to peak between 5% and 5.25%, well above the 4.6% recently forecast by most Fed officials. The Fed is concerned that the costs of doing too little to reign in inflation “likely outweighed” the costs of overdoing it. Federal officials suggested that “a persistent reduction in inflation could require a greater-than-assumed amount of tightening in financial conditions” and a painful U.S. recession cannot be ruled out.
September Prices Surge… “Core” CPI, which excludes food and energy costs, increased 0.6% for the second straight month in September. The 6.6% year-over-year rise in core prices is the biggest in four decades and well above the 5.9% pace just two months back. With September Consumer Price Index (‘CPI’) 8.2% higher than a year ago, a typical American household needs to spend $445 more per month compared to a year ago. Price surges of food, energy, airfares, new cars, and rents have belied expectations. A strong labor market, high wages, labor shortages and supply chain pressures are cited as reasons for elevated prices in the September Fed meeting Minutes released last week. Fed officials noted that risks to inflation are skewed to the upside given upward pressure on wages and energy prices.
States and Locals Brace for Recession Risks…More government officials see a recession looming. Cities expect a 2.5% year-over-year decline in sales-tax receipts for the fiscal year 2022, with nearly no income tax revenue growth over the period, a National League of Cities reported. U.S. cities also budgeting a more than 4% year-over-year drop in property taxes in 2022, as the Federal Reserve’s aggressive policy-tightening regime leads to a housing-market slowdown. Concerns about an economic slowdown led states and local governments to budget conservatively and amass reserves. “I’ve got 15% of our budget set aside in cash. We call it the rainy-day fund,” Connecticut Governor Lamont added “So if capital gains start slipping, which it already has, we’ll be ready.”
Municipal Bond Upgrades Outpace Downgrades…So far in 2022, favorable ratings actions are twice the number of unfavorable rating actions for S&P rated public finance issuers, except for healthcare and housing sectors. Ratings upgrades made up 5% of Fitch rating actions in the third quarter of 2022, while downgrades represented about 1.6%. While municipal bond sectors enjoy a stable outlook, operating pressures led Fitch to assign a negative outlook to not -for-profit hospitals. About 90% of Fitch rated municipal bond credits carry a stable outlook. A slight positive rating momentum for tax-free bond issuers is visible despite high inflation, higher energy costs and supply-chain pressures.
Title III Court Approves Puerto Rico Highway Debt Plan…Bankruptcy Judge Laura Taylor Swain approved the Plan of Adjustment for the Puerto Rico Highway and Transportation Authority last week. “The HTA Plan of Adjustment is extremely positive and reduces its debt by more than 80%, which provides significant relief to our public corporation,” Gov. Pedro Pierluisi added “We will continue to manage the finances of our public entities in a responsible way to ensure a future of progress and sustainable economic development for Puerto Rico.” Puerto Rico’s federal oversight board echoed “Confirmation of the plan is an important step for Puerto Rico to end its bankruptcy process under PROMESA and to achieve long-term economic stability and growth.” 2022 brings two major Puerto Rico bond issuers including the Island’s central government and the highway authority to exit Title III bankruptcy.
Investors Bullish on Chicago Bonds…Chicago’s bonds moved into the top one-third of all large U.S. cities in 2022, after lagging behind peers from 2019 to 2022 per a bond index from the University of Chicago Center for Municipal Finance. The index tracks price changes across general obligation bonds in 50 major cities from a January 2018 baseline. Even as the municipal-bond market is down overall, Chicago bonds have been outperforming their peers, with an index reading of 87.7 on Sept. 19 as compared to 77.8 for the 50 most populous US cities. “A lot of investors are looking at Chicago and saying that its outlook is as good as any large city at the moment,” the researchers added “Investor sentiment is a reflection of the stabilizing fiscal conditions.”
More Bipartisan Policy?…More bipartisan policy, and fewer lawmakers who call themselves ‘moderates’ could be outcomes of the November general election. The first election post-redistricting will likely divide Congress. Republicans winning the House majority and a toss-up for the Senate majority are among varied forecasts by political analysts. President Biden’s agenda items could take a backseat should Republicans make the most of hot-button topics such as inflation. Republicans have already promised a close examination of President Biden’s infrastructure spending should they gain control of committees. Politics is baked into many facets of state and local government funding activities. For investors, it is policy that matters not politics.
Top Municipal Bond Issuers…New York and California issuers are dominant on the tax-free bond primary calendar. New York City Transitional Finance Authority has issued the most municipal bonds this year, ousting the State of California which fell to the fourth spot. Five New York credits including DASNY, Triborough Bridge and Tunnel Authority, New York City and New York State Thruway Authority are among top ten municipal bond issuers ranked by 2022 new issue bond volume. Claiming the eighth rank, Louisiana Local Government Environmental Facilities Authority has jumped up from the 134th spot last year. Miami-Dade County, Florida issued fewer municipal bonds this year, slipping from the top ten but still came within the top twenty tax-free bond volume ranking.
Compare 30-Year taxable U.S. Treasury yield 3.93% to 30-Year tax-exempt muni bond yield “AAA” 3.86%; “AA” 4.37%; “A” 4.95%. For investors in the 35% tax-bracket, a 4.9% tax-exempt yield is equivalent to a 7.5% taxable yield. Top rated long-term tax- free bonds yield 98% of comparable taxable U.S. Treasuries.