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Municipal Bond News 10/2/23
Investors Find Higher Muni Yields Attractive…Muni Bonds Hit-Hard…Individuals Buy More Muni Bonds…Central Bankers Divided…U.S. States’ Pension Burden Dwarfs Debt…Connecticut Boosts Pension Funding…Race For Puerto Rico Governor…
Investors Find Higher Muni Yields Attractive…Investors should be aware of potential “FOMO” or fear-of-missing-out and lock in higher-yields, an institutional investor added “It’s a very compelling opportunity right now just on an absolute yield perspective for munis.” Bank of America, the topmost underwriter of muni bonds stated last week “Muni yields are even more attractive now relative to corporates after recent selloff.” Bank of America analysts echoed. Wealthy residents of high-tax states can earn more investing in municipal bonds right now than in taxable U.S. Treasury bonds or corporate debt, Bank of America strategists said. For example, top tax bracket New Yorkers can currently earn close to 9% taxable equivalent yield from high grade New York muni bonds. That’s about 4.4% points higher, or double the yield currently offered by comparable U.S. Treasury bonds. “On the bright side, absolute yields on high-quality munis already look attractive, in our view,” another strategist told Bloomberg last week. Higher yields are a silver lining for those seeking higher tax-free long-term investments. Lower-rated investment grade muni bonds currently offering as much as 5% tax-free yield, close to 8% taxable equivalent yield. Long term tax-free income investors, be they individuals or institutions, cannot ignore the solid tax-free income currently offered by higher muni yields.
Muni Bonds Hit Hard …Municipal bond returns are headed for the worst month in a year. Muni bond index returns have lost 1.8% this year. Long term tax-free bond yields have surged 50 basis points in September, after climbing 30 basis points in August. As selloff in U.S. Treasuries is pummeling muni bond returns. Longer-dated U.S. Treasury bond yields have risen 82 bps since June-end, touching 4.8% last week, the highest since 2010. Higher yields reflect slower rate cuts next year and in 2025 than the Federal Reserve estimated earlier. Increased borrowings by the U.S. Treasury and Fitch’s downgrade of the U.S. sovereign in August have contributed to the yield surge. The surge in bellwether yields is the largest quarterly jump since the Great Recession.
Individuals Buy More Muni Bonds…In 2023, individuals have bought more muni bonds than they sold. Retail investors boosted their aggregate muni bond holdings by $70 billion in the first six months of 2023 per SIFMA data. Individual investors have been actively buying and selling muni bonds amid volatile markets. This has allowed them to get higher tax-free yields and harvest tax-losses in volatile markets. Despite volatile market conditions, household ownership of individual muni bonds has grown steadily. Individual investors are the largest holders of muni bonds, owning 43% of $4 trillion state and local government bonds outstanding. Safety, tax shelter and yield advantage has made muni bonds a popular investment choice.
Central Bankers Divided… “My current assessment is that we are at, or near, the peak level of the target range for the federal funds rate,” New York Fed President John Williams said the Fed is likely to keep rates high for “some time” to lower inflation. Federal Reserve Governor Michelle Bowman suggested she favors more aggressive rate hikes than other central bankers. Minneapolis Fed President Neel Kashkari suggested last week there’s a 40% chance that interest rates will need to rise “meaningfully higher”. Federal Reserve Bank of Richmond President Thomas Barkin said it’s too soon to know if another interest-rate increase will be needed, noting that headwinds from a potential government shutdown could create more uncertainty for the economy. The Richmond Fed chief, a non-voting member, said that if any government shutdown goes on long enough to interfere with the release of government unemployment and inflation data, it “would be hard to figure out what’s actually happening in the economy.” Bond markets place near even odds of rate hike in November or December, with a slim chance of rate hikes at both Fed meetings.
U.S. States’ Pension Burden Dwarfs Debt…Debt and pension costs make up the bulk of U.S. states’ fixed costs. Pensions are the largest liability for U.S. states. State pension obligations aggregate to $1.75 trillion in 2022. In comparison, U.S. states have collectively issued over $600 billions of tax-supported debt. Tax supported state debt is roughly 37% of aggregate own-source revenue, while pension liabilities are roughly 106% of state own-source revenue per Moody’s. Median fixed costs (pensions and debt) are a mere 4.8% of U.S. states’ own-source revenue. With fixed costs exceeding 20% of own-source revenue, Illinois and Connecticut have the highest fixed costs among U.S. states.
Connecticut Boosts Pension Funding…More than $1.3 billion of CT tax revenue will go towards excess pension contributions to pay down pension debt. About $2.5 billion will fund the state rainy -day fund, bringing reserves to a statutory cap. Budget reform, enacted in 2017 and extended this year through budget legislation, require CT to deposit excess revenue to reserves and pensions. More than $7 billion in excess contributions have been made to pay down pension debt. This is the fourth consecutive fiscal year that additional contributions have been made to pay down pension debt.
Race For Puerto Rico Governor…Puerto Rico’s ruling party, New Progressive Party, is preparing for hotly contested primary ticket. Resident Commissioner Jennifer Gonzalez, the Island’s representative in U.S. Congress will face off with Governor Pedro Pierluisi in the primary for the 2024 gubernatorial election. González previously ran with Pierluisi in 2020. Pierluisi is a former resident commissioner and participated in the enactment of PROMESA, the Island’s debt restructuring law. The winner of the Progressive New Party primary will face leaders of several opposition parties, including the Popular Democratic Party, and a possible alliance of the Puerto Rico Independence Party and Citizen Victory Movement.
Compare 30-Year taxable U.S. Treasury yield 4.75% to 30-Year tax-exempt Municipal Bond yield “AAA” 4.46%; “AA” 4.70%; %; “A” 5.01%. For investors in the 35% tax bracket, a 5% tax-exempt yield is equivalent to a 7.69% taxable yield. Top-rated long-term tax-free bonds yield 94% of comparable taxable U.S. Treasuries.