Municipal Bond News 2/20/24

High Yield Muni Bond Demand Grows…Ratings Upgrades Dominate…Bellwether Yields Surge…Rate Cut Outlook Pales…Silver Lining For Senior Housing… Federal Bounty For U.S. Airports…ESG Bond Issuance Dims…

High Yield Muni Bond Demand Grows…Investors are eager to buy lower-rated muni bonds. Significant additional yield relative to investment grade bonds is available from high yield muni bonds. An index of high yield tax-free bonds yields 5.6% tax-free or about 8% taxable equivalent yield for top earners. That is about 200 basis points more than top-rated tax-free benchmarks. The U.S. economy’s resilience favors lower-rated credits that tend to be sensitive to the economy. emand for high yield muni bonds has soared. Institutional investors have ramped up purchases of high yield muni bonds last year, while selling other types of muni bonds to meet redemptions. A gauge of investor demand, inflows to high yield bond funds, turned positive last year. The most sought high yield muni bonds are typically credits that sit at the middle of the credit rating spectrum: the highest-rated speculative grade bonds or the lowest-rated investment-grade bonds. The most value is “out on the curve and down in credit rating” an expert said. However, investors must do their homework before investing in riskier state and local government bonds. That is where a Municipal Bond Specialist’s expertise in finding and researching the risk-reward of such bonds can offer valuable insight.

Ratings Upgrades Dominate…For the third straight year, Moody’s upgrades have outpaced downgrades in 2023. Continued economic stability and general strengthening of finances across states and local governments contributed to this trend. Local governments and infrastructure lead the way for upgrades. Although healthcare and higher education had more downgrades than upgrades, the outlook for both of these sectors was revised to stable by Moody’s. Notably, a few U.S. states such as New Jersey and Illinois earned ratings upgrades last year. Municipal bond ratings are predominantly investment grade. The charter school sector accounts for the largest portion of speculative-rated issuers. Favorable outlook changes also exceeded unfavorable ones for the quarter, demonstrating continued healthy credit quality across the $4 trillion municipal bond market.

Bellwether Yields Surge…Bond yields have surged to the highest this year. State and local government bonds index yields are about 30 basis points higher in 2024. Bellwether U.S. Treasury yields have moved about 40 basis points higher in February. Bellwether 10-year U.S. Treasury yield hit 4.3% last week, and long-term taxable Treasury bonds yield about 4.44%. Meanwhile, long-term state and local government bonds yield about 3.68% tax-free or 5.6% taxable equivalent. Slower rate cuts, tax-related selling and higher bond issuance have contributed to the surge in muni yields. For long-term investors, the question is where rates will be once inflation returns to target, regardless of whether it takes longer than expected. Last week, WSJ urged its readers, “Even with fewer rate cuts, you should still buy bonds.” Muni bonds offer additional yield relative to comparable U.S. Treasury bonds.

Rate Cut Outlook Pales…Rapid rate cut odds have dwindled, and a rate hike in 2024 cannot be ruled out. Consumer and producer price indices were slightly higher in January from a month ago. The 3.1% annual rise in the consumer price index last month, though slightly higher than consensus forecast, is down from a 9.1% peak in mid-2022. “They’re well within the bounds of what normal…volatility looks like,” San Francisco Fed President Mary Daly referred to the latest inflation reading. Three rate cuts in 2024, as outlined in the Fed’s latest rate projection, are a ‘reasonable baseline assumption’ Daly said. Investors pared back odds of a May rate cut to 29%, down sharply from 70% a week ago. A rate hike in 2024 cannot be ruled out. Bond markets price a 15% chance of a rate hike this year.

A Silver Lining For Senior Housing…High construction costs have put a lid on new construction of senior living communities. The slowdown bodes well for occupancy levels at existing senior living communities. Demand for senior living is poised to grow with the nation’s aging demographic. Senior housing, a $42 billion high-yield muni bond sector that intersects health care and housing, includes assisted living, retirement communities and nursing homes. The senior housing sector faced an onslaught of financial pressures during the pandemic. Still, the sector faces challenges including continued high labor costs and slower home price growth.

Federal Bounty For U.S. Airports…Over 100 airports are poised to receive close to $1 billion in federal grants. Chicago O’Hare, Fort Lauderdale airports are among the biggest beneficiaries. The latest round is on top of the nearly $2 billion granted to airports over the past two years for capital improvement projects. U.S. airports need $151 billion over the 2023-to- 2027 period to meet capital needs. Passenger traffic has rebounded to pre-COVID-19 levels last year. Airport bond issuance has soared as the sector modernizes aging infrastructure and adapts to climate change.

ESG Bond Issuance Dims…Political headwinds and policy actions will dampen the issuance of ESG-labeled bonds in 2024, as was the case last year. Last year, $42 billion bonds were issued for green, social, or sustainability-related purposes, broadly labelled ‘ESG’ bonds. Florida has enacted legislation that prohibits the sale of ESG-labelled or designated bonds. 49 U.S. states have issued at least one ESG bond over the last decade. Affordable housing sector will account for the majority of ESG bond issuance in 2024. Mass transit operators and state power utilities are likely to embrace ESG bond issuance. Over one-in-four ESG bonds is issued in the State of New York. New York Transportation Development Corporation issued the largest ESG bond in the muni market’s history.

Compare 30-Year taxable U.S. Treasury yield 4.44% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.68%; “AA”3.93%; “A” 4.27%. For investors in the 35% tax bracket, a 3.7% tax-exempt yield is equivalent to a 5.7% taxable yield. Top-rated long- term tax-free bonds yield 83% of comparable taxable U.S. Treasuries