© 2023 THE GMS GROUP, LLC. Member of FINRA and SIPC / BrokerCheck All rights reserved.
High Municipal Bond Yields…Above 6% taxable equivalent yields for top tax-bracket investors are attractive. Investors who bought tax-free municipal bonds this month, have locked in decade high yields. Taxable-equivalent municipal bond yields were as much as 7% earlier this month. Since then, surging demand and lower supply of municipal bonds have led to price gains for debt issued by states and local governments. As an asset class, municipal bonds are generally rated ‘AA-‘, indicating a greater degree of safety than corporate bonds, which carry a lower average rating of ‘BBB+’. Volatile market conditions have led to bargain prices of municipal bonds. Longer-dated maturities are particularly attractive, with tax-free municipal bonds yielding over 90% of comparable taxable U.S. Treasuries. Institutional investors are uncovering compelling value in municipal bonds rated ‘A’ and ‘BBB’, anticipating that such investments will outperform for the next few years. High tax-free yields are drawing in wealthy investors, who find that municipal bond yields have not looked so attractive in years.
Fed’s Inflation Gauge Slows…Welcome news for bondholders, a marked slowdown in the personal-consumption expenditure index signals that the Fed’s policy actions are at work. The core PCE index, the Fed’s preferred inflation metric, rose 0.2% in November, lower than estimates and prior month’s reading. The annual rate moderated to 4.7% in November, down from 5% prior month. In the past few months, many inflation measures have fallen more quickly than forecast. Rents and housing prices are falling rapidly, and the supply chain is back to normal. New home sales are well below last year’s levels. Shipping rates are below pre-COVID-19 levels. A University of Michigan survey shows consumers expect inflation to be 4.4% a year from now, lower than prior survey results. Americans are more optimistic on the inflation outlook.
Signs of Slower Economy…Inflation has eroded consumer purchasing power. Consumers and business spending rose 0.1% in November, a sharp pullback from last month’s robust 0.9% increase. Fewer orders for durable goods suggests ebbing demand. Most economists expect a recession in 2023. In a recession, municipal bond prices usually rise. A recession leads investors to seek ‘safety’ when investing, and they move cash into government bonds. A recession causes central banks to eventually respond by cutting rates to bolster the economy. With credit quality at its highest in a decade, states and locals are well-prepared to weather a recession. Slower demand helps support expectations for lower inflation for 2023
Favorable Rating Actions Surpass Downgrades…Rating upgrade actions in the overall municipal bond market surpassed downgrades by two-times in the third quarter of 2022, S&P said. Airports, utilities, local governments and school districts received the bulk of rating upgrades in the third quarter of 2022. Healthcare, higher education and housing sectors saw more downgrades relative to upgrades. Municipal bond issuers credit quality remained largely stable in the third quarter of 2022.
Municipal Bond Supply Lags Tax-Free Demand…In January, investors are set to receive about $20 billion from municipal bond redemptions. Those looking to re-invest for replacing tax-free income are likely to face supply shortages. Not enough new tax-free bonds will be sold in the primary market in January. November and December saw a steep decline in municipal bonds. November primary market volume was only half of last year’s levels. December issuance has lagged even more. 57% fewer municipal bonds were sold in December from a year ago. New leaders elected last month will take some time to roll out capital agendas. With government coffers overflowing with recent revenue outperformance and federal aid, states and locals are likely to defer borrowing plans in a high rate environment. Municipal bond supply lags will likely continue for the next few months.
Puerto Rico Medicaid Funding Boost…Lawmakers reached a deal that renews healthcare access to more than a million Puerto Ricans. The deal brings over $17.6 billion in Medicaid funds to Puerto Rico over the next five years. The federal government will cover 76 cents of every dollar spent by Puerto Rico on Medicaid. Puerto Rico and other U.S. territories receive a fixed amount of federal funding for Medicaid, with a spending cap that can fall well short of expenditures. Failing to pass a deal could cut health care and safety-net benefits. Aside from “Puerto Rico avoiding its looming Medicaid funding cliff,” Sen. Chuck Schumer, D-N.Y., who helped negotiate the deal, said that “the record levels of funding provided in the bill will allow us to expand access to care for our fellow American citizens on the island and ensure long-term stability for Puerto Rico’s hospitals, providers and health care system.”
MTA Hikes Fares…To boost recurring revenue, the largest transit system in the U.S. hiked fares by 5.5% as part of its $19 billion approved budget for Fiscal 23. MTA is counting on additional state and city funds to fill a $600 million budget deficit next year. Its projected deficit could grow to $1.2 billion in 2024 and $3 billion in 2025 as federal pandemic aid is set to run out. By 2026, MTA’s ridership is likely to reach 80% of pre-pandemic levels, up from 60% currently. “The ridership trends that have emerged post-COVID have created a fiscal cliff higher and earlier than previously anticipated,” MTA CFO added “The much-needed federal aid the MTA received from three COVID-relief packages has enabled a reduction in deficits in the immediate future. However, beginning in 2023, we need new dedicated revenue streams to ensure that essential transit service remains at the levels riders expect.” MTA’s congestion pricing plan, or extra tolls for driving in Manhattan’s central business district, could yield $1 billion of annual recurring revenue, a bright spot.
Airports Bounce Back…Air passenger traffic hit a post-pandemic high in 2022. TSA screenings, a proxy for enplanements, rose to near 95% of 2019 levels during Thanksgiving. Travel is poised to ramp up in the Spring as airlines boost capacity. By year-end 2023, air travel is expected to reach 100% of pre-COVID-19 levels. Fewer travel restrictions in Asia and Europe have boosted international passenger volumes. A stronger dollar is a boost to outbound international gateway airports. Population inflows spurred by the pandemic have made certain airports, such as those in Austin and Nashville, a lot busier. However, inflation and a looming global economic slowdown are headwinds. Faced with labor issues, many airlines cut back on flights in 2022. The Bipartisan Infrastructure Law brings over $15 billion over five year to airports. Most airport ratings are now the same level or higher than pre- pandemic “as air travel accelerated and paved the way for a recovery in activity-based revenues and more predictable financial performance,” S&P stated. Moody’s echoed that the airport bond sectors’ positive rating momentum continues. Amid strong travel recovery, several airports including Los Angeles, San Diego, Denver and Chicago O’Hare issued new bonds in 2022. In a supply starved municipal bond market, more airport bonds were issued in 2022 than a year ago. The largest airport bond sale in 2022 is the $1.8 billion Chicago O’Hare airport municipal bond issue, that was four-times oversubscribed. Next year, tax-free investors await new airport bonds issued by Austin, Atlanta, and San Antonio.
Compare 30-Year taxable U.S. Treasury yield 3.85% to 30-Year tax-exempt muni bond yield “AAA” 3.55%; “AA” 4.09%; “A” 4.64%. 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 92% of comparable taxable U.S. Treasuries.