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Investors Bullish on Municipal Bonds… Growing calls that municipal bonds could turn around from 2022 losses to outperform next year. Morgan Stanley predicts 8% total returns, and Oppenheimer expects mid-single digit returns for municipal bonds in 2023. PIMCO says that beaten-down bonds are due for a rally if a recession hits. BlackRock Inc. anticipates a stronger year for fixed-income and said seasonal factors are likely to turn much more favorable in the coming weeks. Municipal bonds have gained 2.5% this month, the best returns since August. New bond supply is almost 20% lower than a year ago, and demand is poised to rebound. Investors will receive over $64 billion of cash from municipal bond redemptions and maturities over the next three months, which likely will seek to be reinvested. The current market environment is a ‘sweet spot’ for municipal bonds, a strategist said, while another is ‘definitely bullish’ on the $4 trillion municipal bond market. High tax-free yields on municipal bonds are catching the attention of long-term investors.
Cash Inflows to Municipal Bonds… Inflows to municipal bond funds last week signify a rebound in demand for municipal bonds. Higher municipal bond yields have led investors to buy municipal bonds. This year, municipal bond funds were forced to sell tax-free bonds worth about $118 billion to meet redemptions by investors. However, outflows from such bond funds tapered down in the third quarter to about $14 billion, significantly lower than prior quarter’s $54 billion. Year-to-date trading in the municipal bond market is up 61% in 2022 compared to a year ago when bond yields were at sixty-year lows. A municipal bond regulatory body noted “The dramatic increase in trading in 2022 has been driven mainly by a significant increase in demand for municipal bonds by individual investors as bond yields have risen.”
Wholesale Prices Soften…The October producer price index data showed wholesale prices up 8% from October 2021 and down significantly from the 11.7% peak in March. In month-over-month terms, producer prices rose 0.2% in October, the same as prior month. Wholesale prices echo a better-than-expected drop in headline consumer prices. Although October retail sales were higher than expected, consumers are spending less on retail purchases in inflation-adjusted terms. Industrial production contracted in October. The U.S. economy “is possibly in a recession”, the Conference Board said last week, after its leading economic index which gauges the business cycle dropped for the eighth straight month in October.
Chicago Bond Plans… Chicago will be an active issuer of new municipal bonds in the coming months on the heels of recent credit upgrades. The Windy City’s first-ever social bonds will be issued next month by its sales tax securitization corporation, followed by a $750 million general obligation bond issue. A $700 million water utility bond issue, as much as $500 million in sewer utility bonds and up to $1 billion for Midway International Airport bonds are in the pipeline for the first quarter of 2023. “We are going to continue to be in the market even as interest rates fall or rise,” Chicago CFO added “Fiscal stability helps to pay for essential city service.” Rating upgrades from two ratings agencies and favorable outlook revisions are a ‘big deal’ for the city, an institutional investor said. Lower credit spreads, the yield gap from top-rated municipal bond benchmarks, is likely.
Illinois Eyes Higher Surplus… Soaring income and sales taxes will boost Illinois’ general fund surplus to almost $1.7 billion in Fiscal 2023. Governor Pritzker’s office forecasts $357 million surplus in fiscal 2024, a shift from a previous projection for a $3 billion shortfall. The fiscal 2025 gap was narrowed from $3.2 billion to $384 million. Illinois’ finances steadied after massive federal aid helped pay-off a unpaid bill backlog. Today, Illinois pays its bills on time and there are plans to double the state rainy day funds to over $2 billion by next year, which “continue Illinois’ strong path forward, and put the state in the best possible fiscal position to prepare for the economic uncertainty that lies ahead.”
California Warns of Deficit… “Reflecting the threat of a recession, our revenue estimates represent the weakest performance the state has experienced since the Great Recession,” California Legislative Analysts warned. California is likely to see a $25 billion deficit in Fiscal 24 which begins next June. The gap, which comes after a record budget surplus of $97 billion in Fiscal 22, will gradually fade to a $8 billion in Fiscal 27. Falling stock prices could weigh on the state income and capital gains tax collections. The deficit forecast is a ‘realistic and reasonable assessment’, California’s finance department noted, “The good news is that as we prepare to close a budget shortfall, the state is in its best-ever position to manage a downturn, by having built strong reserves and focusing on one-time commitment.” California actual revenue collections in Fiscal 23 through October are 5% higher than projections.
New Puerto Rico Oversight Board Chief… New York State Budget Director, Robert Mujica, who hails from Puerto Rico, has been appointed as the Executive Director of the Island’s oversight board. Mujica replaces former ED Natalie Jaresko. David Skeel, the board’s chairperson terms the new appointment a ‘game changer.’ Mujica said, “It is a special place to me, and I want to see it prosper.”
U.S. Lawmakers Seek Answers on PREPA… At a U.S. House Natural Resources Committee hearing last week, Governor Pierluisi indicated that PREPA debt negotiations may extend past the deadline. The oversight board and the government are “doing their best to reach a consensual agreement,” Governor Pierluisi added “I can’t rule out there will be settlement negotiations along the way but I’m not going to allow PREPA to end up with a debt burden that’s going to cause extraordinary increases in the cost of electricity for the people. U.S. lawmakers questioned the operations of the electric grid, particularly the 2021 transmission and distribution contract with Luma Energy. Governor Pierluisi extended his support to Luma, and said they are being ‘closely watched.’ Resident Commissioner Jennifer González Colón said that the “The biggest challenge facing Puerto Rico is the unstable condition of the grids.”
Voters Decide… Massachusetts and Colorado voters hiked taxes on high-income taxpayers, whereas California voters nixed an additional 1.75% wealth tax levy. Unions’ collective bargaining rights were boosted as Illinoisans are adding a new amendment to the state constitution that will dedicate a “fundamental right” for workers to unionize. California voters overwhelmingly rejected sports betting in the most expensive ballot proposition in U.S. history. A Mansion Tax in Los Angeles, expanded Medicaid access in South Dakota, rent control, police governance and many other government matters were decided at the November poll, the first chance for ballot measures since the Covid-19 pandemic was brought under control.
Compare 30-Year taxable U.S. Treasury yield 3.89% to 30-Year tax-exempt muni bond yield “AAA” 3.65%; “AA” 4.16%; “A” 4.74%. 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 94% of comparable taxable U.S. Treasuries.