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Municipal Bond News 11/6/23
Relative Value in Tax-Free Bond Yields…Bellwether Yields Drop…‘Municipal Bonds Offer Fantastic Yields’… Have Policy Rates Peaked?…Airport Bonds Fly High… Fitch Downgrades Surpass Upgrades…Lower Income Tax Weighs on State Revenue… State General Obligation Bonds Sought…
Relative Value in Muni Bond Yields…Starting November with gains, muni bond indices show positive returns of 1.8% so far this month, breaking a streak of losses in three prior months. Top-rated muni bond yields dropped about 15 basis basis points last week, lower than a roughly 30 basis point decline in comparable U.S. Treasury bonds. The shift has boosted the relative value of state and local government bonds. Top-rated muni bonds offer about 97% of taxable U.S. Treasury yields. Seasonally, November tends to bring positive returns for muni bondholders due to seasonal supply and demand trends. Demand for tax-free reinvestment and tax-loss harvesting is expected to increase. Investors are set to receive a flood of cash from interest and principal payments in November and December. Fewer muni bond offerings are expected in the primary market. Over the next 30 days, about $5.5 billion new muni bond issues are expected, or $3 billion less than the 12-month average. With broad muni bond index returns showing a negative 0.42% year-to-date return, investors are likely to continue to replace muni bond losses with higher-yielding tax-free securities amid volatile market conditions. Signals that the world’s largest economy is starting to cool caused bonds to rally. Investors assign fewer odds of additional rate hikes, and higher odds of rate cuts by middle of next year.
Bellwether Yields Drop…Benchmark 10-year U.S. Treasury yields plunged to 4.52% last week, sharply down from the 5% mark hit recently. Policy sensitive two-year U.S. Treasury yields fell to a two-month low of 4.86%. Fueling a bond rally, the U.S. Treasury said it was slowing the pace of increases in sales of long -maturity Treasury bonds. Softer-than-expected job growth contributed to the yield drop. Yields also declined after the Federal Reserve paused rate hikes at last week’s central bank meeting, marking the third consecutive Fed meeting at which policy rates were kept unchanged. Over the past thirty years, a move of this magnitude in bellwether yields has occurred less than a dozen times.
‘Municipal Bonds Offer Fantastic Yields’…“You can earn high yields on municipal bonds right now, while avoiding risk in the stock market. If you are an investor, assumptions built up during decades of low bond yields now have to go out the window. Interest rates are now high enough that you can get compelling returns on municipal bonds, if you take tax advantages into account. This assumes of course that you are paying high-enough income taxes that avoiding them is worthwhile,” MarketWatch stated last week adding, “But bond funds also have fluctuating share prices. If you hold an individual bond until maturity (or until it is called), you don’t have to worry about how much its market value fluctuates. (Bond prices fall as interest rates rise and vice versa.) You know the price you will pay, so your only risk is that of default, which is rare for municipal bonds. And that risk can be mitigated by sticking with investment-grade-rated securities.”
Have Policy Rates Peaked?..Fed officials have now skipped a rate hike for three consecutive meetings, making it the longest period without an increase since they began to lift rates from near zero in March 2022. Fed officials have been trying to balance two risks. They don’t want to overdo rate rises to avoid causing an unnecessarily severe downturn. They also don’t want to allow inflation to reaccelerate or to settle at levels well above their 2% target. “Those risks are closer to being in balance,” Powell said at last week’s Fed meeting adding that financial conditions have tightened significantly in recent months, driven by higher longer-term bond yields among other factors.
Airport Bonds Fly High…An index of airport bonds has gained a 5.6% return this year, defying losses in the broad municipal bond market. Air travel has largely recovered to pre-pandemic levels. Airport traffic at leisure venues such as Miami, Myrtle Beach, Orlando, and Las Vegas exceed pre- pandemic levels. Major hub airports in Boston Logan, Seattle, and Washington DC are in the 95-100% recovery range, due to higher corporate travel demand. Secondary hubs such as Detroit and Philadelphia are seeing airport traffic at less than 90% of 2019 airport traffic levels. A slower recovery is ongoing at West coast hub airports, which are at 80-83% recovery levels per recent Fitch data. Large international gateway airports including Newark report 107% recovery. The airport sectors’ infrastructure needs are estimated to be about $150 billion through 2027. Large hub airports will spend nearly half of this on capital upgrades. Airport revenue, the majority of which comes airline payments, will likely keep pace with higher interest costs.
Fitch Downgrades Surpass Upgrades…For the first time in over two years, Fitch credit rating downgrades surpassed upgrades in the third quarter of 2023. Upgrades made up 2.8% of rating activity, and downgrades were just a tad higher at 2.9%. Rating outlooks are ‘overwhelmingly stable,’ Fitch added “Fitch’s measures of overall credit quality should remain stable and strong given prudent efforts in recent years to bolster financial resilient.” While community housing for the elderly, hospitals and colleges bore the brunt of Fitch downgrades, utilities, transportation-related muni issuers and airports saw a healthy slate of upgrades. Municipal bond credit risk remains low overall, though certain sectors, such as competitive enterprises, healthcare and senior living, continue to struggle as inflation and high interest rates linger.
Lower Income Tax Weighs on State Revenue…New York State expects tax collections to be 10% lower than expected in the current fiscal year. Revenue from the personal income tax, the state’s largest revenue source, is expected to decrease 14.3% this fiscal year. California’s recent income tax collections are significantly below forecast. Golden State tax collections, highly dependent on capital gains and personal income tax revenue, were suppressed by stock market weakness and slowing wage growth. Nearly half of California’s income tax collections come from residents in the top 1% of income earnings. Personal income tax, corporate tax and sales tax are top revenue sources for U.S. states.
State General Obligation Bonds Sought…High tax U.S. state general obligation bonds offer strong credit quality and high tax-free yields. In high-tax states, such as New York, New Jersey, Illinois and Connecticut, investors top tax bracket earners have recently reaped taxable equivalent yields ranging from 8% to 10% for long-maturity, general-obligation debt. Volatile market conditions have persisted across global bond markets. A state general-obligation debt bond index has lost 0.34% year-to-date, outperforming overall muni bond markets’ 0.42% year-to-date loss. Notably, a Puerto Rico bond index has outperformed with a 2.3% gain so far this year.
Compare 30-Year taxable U.S. Treasury yield 4.77% to 30-Year tax-exempt Municipal Bond yield “AAA” 4.50%; “AA” 4.63%; %; “A” 5.05%. 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 97% of comparable taxable U.S. Treasuries.