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Attractive Tax-Free Yields…Municipal bond yields are now in the 3% to 5% range, up from 1% to 2% yield range at the start of the year. Top-rated municipal bonds offer close to 4.2% tax-free yield for 30 years which is about the same as taxable United States Treasury yield. Higher, 4.5% to 5%, yields are available on high-grade long-term municipals. New York’s Triborough Bridge and Tunnel Authority 4% coupon bonds due in 2046 offer 5.2% tax-free yield, while Chicago O’Hare airport bonds offer about 5.25% tax-free yield. Unrated Puerto Rico COFINA bonds offer about 6% tax-free yield. High-yield 5% coupon Ohio Tobacco bonds, the largest bond issue backed by tobacco settlement revenues, offers about 6.1% tax-free yield. In contrast, United States Treasuries offer 4.1% taxable yield or about 2.58% after-tax yield for top-tax-bracket investors.
Municipal Bonds an ‘Excellent Buying Opportunity’…With municipal bond yields at 15-year highs, municipal bonds look like an ‘excellent buying opportunity’ Barrons wrote this weekend. “The combination of higher yields and improving credit quality has made municipal bonds very attractive,” Pimco’s municipal bond head stated. High inflation and steep federal funds rate hikes led investors to pull out almost $100 billion from municipal bond funds. BlackRock strategists think that municipal bonds could rally when investors sense that the “Fed is near the end of the tightening cycle.” Municipal Market Analytics echoed that “a faster pricing rebound” amid dwindling supply of municipal bonds is likely once interest rates stabilize. For patient long-term investors who can withstand near-term paper losses amid steep price declines, some ‘in-state’ municipal bonds offer steady income of as much as 10% taxable equivalent yield for top-tax-bracket investors after accounting for shelter from state and federal income taxes.
Municipal Bond Supply Woes…This year, states and local governments issued 17% fewer municipal bonds compared to a year ago. The supply lull was most conspicuous in the tobacco bond sector. There were no tobacco settlement bonds issued this year after over $8 billion were issued in 2021. Pension obligation bond issuance is also 70% lower than last year’s new issue volume. The lower supply trend is likely to persist through early 2023. With 36 governors facing re-election battles on November 8, political tasks of new administrations will take priority over the next few months. Moreover, January typically offers a scarce primary bond offering calendar. However, municipal bond issuance could pick up later in 2023, Bank of America strategists note, “2023 should be a much friendlier year as the Fed is expected to wrap up its intensive tightening program in the first few months, and eventually begin an easing cycle later in the year during a prolonged recession.”
High Inflation…A Fed-preferred inflation gauge, PCE price index, is up 0.3% in September from a month ago, and 6.2% higher than a year ago. Core prices, excluding food and energy, are 5.1% higher than last year, lower than 5.2% forecast. The PCE index reading, which echoes the CPI inflation gauge, leaves the Federal Reserve on track to hike fed-funds policy rate by 75 basis points at this week’s Fed meeting.
Recession Risks…The U.S. economy is still struggling with painfully high inflation and rising interest rates as the Federal Reserve works aggressively to quell wage and price pressures. With mortgage rates rising at a fast pace, new home sales are rapidly slowing. Savings rate dipped to a 14-year low in September, although income is 0.4% higher than prior month. U.S. GDP grew 2.6% in the third quarter, after two consecutive quarterly declines. Weaker growth in the fourth quarter is expected, Morgan Stanley strategists noted”3Q22 to mark the peak in quarterly growth, as the cumulative effect of tighter monetary policy begins to push growth below potential.” Many economists fear that the U.S. economy could tip into a recession next year.
PREPA Lien Challenge…Summary judgement on the bondholder lien on Puerto Rico’s electric utility revenues is sought by the oversight board. “To facilitate the massive scale of [PREPA’s] borrowings, PREPA and the Commonwealth [of Puerto Rico] had to assure bondholders that they would be repaid from the revenues generated by that system over the decades required to repay the debt,” bondholders and bond insurers claim that they are owed $8.3 billion in principal and billions more of unpaid interest. The oversight board argues that bondholders have legal claim to just the sinking fund which has a few million dollars. The sinking fund must be replenished with utility revenues per the trust indenture, argue bondholders. Bondholders have asked Judge Swain for her interpretation of the law. The mediation team is expected to deliver a debt plan by January 31, 2023.
Federal Infrastructure Bounty…U.S. states are set to receive $60 billion in Fiscal 23 as federal transportation funds. This marks the second year of funding from $1 trillion Infrastructure Investment and Jobs Act. The massive infrastructure spending law signed last November which provides five years of increased federal appropriations for improving roads and bridges finds itself in controversy amid inflation at a forty-year high. Fy23 funding is 25% higher relative to pre-IIJA federal transportation funding. Texas and California will receive the most, at over $5.5 billion, followed by New York at $2.7 billion, and New Jersey at $1.6 billion.
Illinois Sports Bets Overtake New Jersey…Sportsbooks in Illinois are the second largest in the United States. New Jersey, the first U.S. state to offer legal sports bets, has been pushed down to the third spot. Online casino games could be the next stop for the Land of Lincoln cheered by the runaway success of online sports betting within just a few short months of legalization. Only six U.S. states offer online casino games, although in-person gambling is legal at casinos in 48 U.S. states. Should Californians vote to allow sports betting in the Golden State, U.S. states’ stakes in the gaming industry could be upended yet again.
Compare 30-Year taxable U.S. Treasury yield 4.15% to 30-Year tax-exempt muni bond yield “AAA” 4.17%; “AA” 4.77%; “A” 5.26%. 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 100% of comparable taxable U.S. Treasuries.