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Municipal Bonds’ Best Monthly Returns… Municipal bonds kicked off December on a high note with recent gains the highest in 36 years. Municipal bond indices gained over 4.6% in November, the highest monthly return since 1986. Longer dated municipal bonds outperformed with a 7.8% index return. High yield municipal bonds posted a 5.8% index return, with 7.4% index returns for Puerto Rico’s triple tax-exempt bonds. Investors are buying municipal bonds amid optimism that Federal Reserve rate hikes are beginning to cool prices. December sees higher demand for tax-free reinvestments. Investors received over $31 billion in interest and principal payments from states and local governments last week. Meanwhile, the volume of new municipal bonds issued last month fell to the lowest in 25 years. Municipal bond yields have dropped about 50 basis points in the last month. Recent gains have pared back the municipal bond sector’s worst losses in several decades. Municipal bond indices show negative 8.3% index returns so far in 2022, outperforming a negative 10.9% return for comparable U.S. Treasuries. Expectations of a mild recession and an end to the Federal Reserve’s tightening cycle in 2023 boost the outlook for municipal bonds next year.
Powell Hints Slower Rate Hikes… “The time for moderating the pace of rate hikes may come as soon as the December meeting,” Fed Chair Powell added that “I will simply say that we have more ground to cover.” Inflation forecasts from Fed officials point to a “significant decline over the next year”, Powell explained that further declines in goods and home prices could put downward pressure on inflation. However, the “path ahead for inflation remains highly uncertain”. Although inflation eased in October, the Federal Reserve would need “substantially more evidence to give comfort that inflation is actually declining”. “My colleagues and I do not want to overtighten,” Powell signaled. Fed-funds futures are pricing in a peak target rate of 4.75%-5%, down from 5%-5.25% earlier. With one-in-four odds for a fifth consecutive 75-basis rate hike next week, a 50-basis point rate hike is likely next week.
Municipal Supply Hits 25-Year Low… November saw the lowest volume of new municipal bond issuance this year. States and locals sold 47% fewer municipal bonds in November-22 relative to last year. Supply hit a 25-year low last month, with refunding bond volume down close to 80%. Faced with high interest rates, states and local governments are holding off from financing new capital projects. 2022 new municipal bond volume, $346 billion so far, is 19% lower than a year ago. Most Wall Street analysts expect between $350 billion to $420 billion of new municipal bonds to be issued next year. Low supply is likely to persist in 2023.
MTA Budget Gap Grows… Ridership woes and pension costs have led to the budget gap to be higher than earlier estimated. MTA is seeking $4.65 billion of combined new government funding between 2023 and 2026. It may resort to a 4% fare hike and/or service cuts and layoffs if additional state and city aid does not arrive. A new labor contract is also anticipated. It received about $15 billion in federal COVID-19 related federal aid, which is set to run out in 2025. The MTA’s survival depends on additional state, city and federal funding, MTA chief aid added “For New Yorkers, mass transit is like air and water.”
PREPA Talks Extended… Judge Swain has granted a one-week extension to the mediation team negotiating Puerto Rico electric debt deal. The mediation team sought the extension citing that the basic data and analysis needed for negotiations is still pending. Meanwhile, the oversight board has made a pact with fuel lenders. The pact provides fuel lenders’ $700 million claim with new bonds that carry a higher payment priority than those to be issued to satisfy over $9 billion legacy bondholder claims. Such bonds are slated to be paid by a hybrid of a flat connection fees and a volume-based charge on electric bills. “We will continue to negotiate with other creditors to reach a plan of adjustment that would allow PREPA to move on and continue to transform into a modern and reliable energy system,” oversight board chairman added “This is a big step towards getting PREPA out of bankruptcy.” Separately, LUMA Energy has received a temporary extension of its 2021 contract to run electric transmission and distribution on the Island. A weak electric grid, mismanagement and governance issues have been blamed for frequent power outages. Governor Pierluisi said that leaving the grid in Luma’s hands was the best way to expedite more than $12 billion in federally funded projects earmarked to overhaul the system.
Chicago Mayoral Race Kicks Off… Mayor Lightfoot has made her bid for a second term in Chicago’s top office. Lightfoot will have to overcome a serious challenge from U.S. Rep. Jesús “Chuy” García. García first ran for mayor in 2015, forcing then-Mayor Rahm Emanuel into a runoff. As a former Chicago Teachers Union chief, Garcia has the support of powerful labor unions. Cook County Board of Commissioners member and CTU organizer Brandon Johnson is also in the race, which has close to a dozen contenders.
States and Locals “Well-Positioned” For Mild Recession, Fitch… The United States is likely to tip into a mild recession in the second quarter in 2023, Fitch said. An economic slowdown shapes into weaker government tax collections. A rapidly cooling housing market and a weak commercial real estate market that has not recovered from pandemic shift could pressure property tax collections. Federal aid, a driver of recent government budget outperformance, has largely ended. With robust reserves, in many cases exceeding pre-pandemic levels, and strong budget management, states and local government are ‘well- positioned’ for an economic slowdown.
Compare 30-Year taxable U.S. Treasury yield 3.56% to 30-Year tax-exempt muni bond yield “AAA” 3.51%; “AA” 3.97%; “A” 4.67%. 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 99% of comparable taxable U.S. Treasuries.