Municipal Bond News 11/20/23

Muni Bond Returns Turn a Corner…Record Demand for Muni Bonds… Has the Fed Defeated Inflation…Moody’s Muni Bond Upgrades Surpass…Muni Bond Issuers’ Resilient to USA Credit Outlook Change…Chicago Closes Budget Gap…Judge Advances Contested PREPA Debt Plan…

Muni Bond Returns Turn a Corner…An inflection point for muni bond yields has come into view this month. Yields on top-rated muni bonds have dropped more than 50 basis points this month. The drop comes after yields soared to 12-year- highs last month. Muni bond yields peaked at the end of October. For three straight months ending October, municipal bonds posted losses amid a Treasury bond selloff. The rout in bond prices took tax-free yields to the highest since 2007 and brought equity-like returns for top tax bracket buyers of in-state muni bonds in high-tax states. The bond rally comes in the wake of weaker-than-expected inflation. The data-dependent Fed is likely to continue its pause on rate hikes amid signs of a cooling economy. Volatile market conditions have persisted. Historically, bellwether bond yields have fallen between the last rate hike and the first rate cut. “The bull market for muni bonds is underway,” Bank of America, the largest underwriter for state and local governments said. November is poised to bring gains for state and local government bonds. This month, a broad muni bond index has gained 4%, pushing the year-to-date muni bond returns to 1.7%. November’s sharp rally is pushing investors to lock in higher tax-free yields while they last.

Record Demand for Muni Bonds… A reckoning that short term cash yields, which are taxable, are transitory has boosted the allure of fixed tax-free income. Municipal bond daily trading volume surged in November; surpassing highs reached a year ago. Investors are flocking to buy muni bonds to take advantage of attractive tax-free yields. “Trade volumes are up so much because munis are the cheapest it’s been in about a decade,” an institutional investor told Bloomberg “There is this fear that if I don’t get involved at this moment, I will miss my opportunity to buy munis at such attractive levels.” Individuals have added to muni bond portfolios this year, and also sold to harvest tax losses, reflected in the higher trading volumes. Top-rated long term muni bond yields are about 90 basis points higher than this year’s low of 3.21% hit in April. Top-rated long term muni bonds offer taxable equivalent yield of about 6.35%, or 175 basis points higher than taxable U.S. Treasury yields.

Has The Fed Defeated Inflation…The effects of aggressive rate hikes are finally rippling across the U.S. economy. The U.S. economy could slow to a 1% growth rate in the last quarter of 2023 per S&P, after strong growth earlier this year defied expectations. Inflation has eased more than expected. Core inflation ran at an annual rate of 2.8% for the five months ended in October, down from the 5.1% pace during the first five months of the year. October retail sales fell for the first time since March. Slower hiring and cooling wages suggest an imminent slowdown. The world’s largest retailer expects a period of disinflation in the months to come. A few market experts suggest higher unemployment in the near future, and that inflation could turn negative in 2024. “The hard part of the inflation fight now looks over,” Goldman Sachs’ economists stated. “We may have brought down inflation as fast as it has ever come down, and we did that without starting a recession,” Chicago Fed President Austan Goolsbee recently stated, pointing to a ‘soft landing’ sought by the Fed.

Moody’s Muni Bond Upgrades Surpass… Moody’s rating upgrades exceeded downgrades in the third quarter of 2023 by over three times. For the 11th quarter in a row, Moody’s upgrades have surpassed by a wide margin. Favorable outlook changes also outpaced unfavorable ones. This reflects continued healthy credit conditions broadly across municipal bond issuers. The healthcare sector remains an exception with downgrades leading upgrades for the fifth straight quarter, though the gap closed slightly. The largest issuer to be upgraded by Moody’s in the last quarter is Pennsylvania Turnpike Commission.

Muni Bond Issuers’ Resilient to USA Credit Outlook Change …Majority of municipal bond issuers are not affected by Moody’s recent outlook change of the United States of America (Moody’s ‘Aaa’ S&P ‘AA+’ Fitch ‘AA+’) to negative from stable. U.S. states are sovereign entities, with fiscal autonomy. Local governments’ ability to raise revenue are governed by states and local limits. Very few local governments have relatively high exposure to federal resources, such as federal employment bases, or federal financial disaster relief. Material funding for certain programs such as transit and Medicaid, crucial to many states, come directly from the federal government. Despite revenue from the federal government or other linkages, higher education, healthcare and most housing finance issuers are broadly resilient, Moody’s noted. Federal funding makes up about quarter of state revenue, about 6% of local government revenue and 11% for school districts. For states and local governments, federal funding is important, but taxes are the largest revenue source.

Chicago Closes Budget Gap…Chicago lawmakers have approved the mayor’s $16.6 billion budget plan for Fiscal 24, which begins on January 1. The budget closes a yawning budget gap of $538 billion. Favorably, city tax collections have outperformed. Chicago will pull a record $433 million money from tax -increment financing projects, a tactic previously used to leverage Chicago’s vast and valuable real estate. Cost savings, improved revenue enforcement and bond refinancing are in the budget plan. Continued supplement pension payments are a notable highlight of the Brandon administration’s inaugural spending plan. Brandon has done away with inflation-indexed property taxes causing the budget gap to grow. Much of Johnson’s election agenda, such as $800 million in new “tax-the-rich” levies, among them a revived corporate head tax, a charge on securities trades and a higher hotel tax have been shelved for now. While Chicago has improved its debt management practices and benefited from a continued economic recovery, uncertainties include migration costs, reliance on one-time revenues like TIF surpluses, and the city’s “persistent structural imbalance”, a watchdog group, the Civic Federation noted. The Windy City’s spending plan is about 2% larger than prior year.

Judge Advances Contested PREPA Debt Plan…Holders of 50% of Puerto Rico electric utility (‘PREPA’) bonds have recently filed at least three lawsuits challenging the legality of the latest debt plan. GoldenTree Asset Management and Syncora Guarantee sued Puerto Rico’s central government for manipulating PREPA’s fiscal plans and budgets to deprive the bondholders of their claim on the authority’s revenues and depress the value of the bonds. Bondholders allege that the oversight board and PREPA illegally tried to buy creditor votes, and that such votes procured in bad faith be disqualified. Some PREPA bondholders are offered a 40% recovery, while others would be given a mere 3.5% recovery per the board’s latest offer to bondholders. GoldenTree and Assured Guaranty have filed an alternative proposal that would treat creditors equally and potentially save PREPA even more money on fees. Meanwhile, Judge Swain held a hearing to approve the debt plan’s Disclosure Statement last week, at which she stated that bondholder objections are ‘premature’ and should be considered at a later stage. While Judge Swain advanced the latest debt plan, it faces opposition, litigation, and potential appeals.

Compare 30-Year taxable U.S. Treasury yield 4.62% to 30-Year tax-exempt Municipal Bond yield “AAA” 4.13%; “AA” 4.35%; %; “A” 4.79%. For investors in the 35% tax bracket, a 4.2% tax- exempt yield is equivalent to a 6.46% taxable yield. Top-rated long-term tax-free bonds yield 89% of comparable taxable U.S. Treasuries.