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Municipal Bond News 2/21/23
Municipal Bond 2023 Gains Slide Lower… Policy Rates Higher for Longer Likely… Fed Officials Mull Larger Rate Hikes… Inflation Eases, Defies Estimates… Detroit Tax Revenue Trends Higher… Illinois Budget Boosts Reserves, Pension Funding…
Municipal Bond 2023 Gains Slide Lower…In February, municipal bond market has lost 1.8% so far, relative to higher 2.1% losses for comparable taxable Treasury bonds. February losses come after municipal bonds posted historically strong returns in January. Municipal bonds have returned close to 1% so far this year, after 8.5% losses last year. On February 1, Fed Chair Powell said that the ‘disinflationary process’ has begun. Soon after, higher-than-expected January jobs growth, retail spending and inflation readings defied consensus forecasts. The U.S. economy is in better shape than earlier expected. Robust consumer spending is keeping prices elevated. “Inflation is normalizing, but it’s coming down slowly,” Richmond Fed President Thomas Barkin explained. Prospects of larger-than -expected fed-funds rate hikes loom large. Demand for municipal bonds cooled off last week, after investors poured cash to buy municipal bonds for five straight weeks in 2023. Top-rated long-term municipal bond yields rose last week. New municipal bonds issued last week were repriced to higher yields than anticipated. Fed officials reckon it could be a ‘long battle against inflation.’ Investors are looking to get a better window into the pace of future rates hikes and the level of peak policy rates.
Policy Rates Higher for Longer Likely… Futures markets raised odds of three additional quarter-point rate hikes in March, May and June this year, and dialed back prior expectations of rate cuts in 2023. No longer dismissive of Federal Reserve’s interest rate projections, investors anticipate the fed-funds rate to peak around 5.27%, up from a range of 4.5% to 4.75% at present. A stronger-than-expected economy has boosted odds that the Federal Reserve could raise rates higher than 5.1% peak fed-funds policy rate forecast by most central bankers in December. Bank of America estimates that rate cuts may not happen until March 2024. Morgan Stanley estimates continued labor market strength could put 50 basis point rate hikes back on the table. Goldman Sachs estimates a peak policy rate of 5.5%.
Fed Officials Mull Larger Rate Hikes…At least three voting Federal Reserve members, including Dallas Fed President Lorie Logan, New York Fed President John Williams, and Philadelphia Fed President Patrick Harker stated last week that the Fed ‘might raise rates higher’ and ‘for a longer period than previously anticipated’. A ‘compelling case’ for a 50- basis point rate hike at the Fed’s next meeting is envisioned by non-voting Cleveland Fed President Loretta Mester. Another non-voting central banker, St. Louis Fed chief James Bullard wants to bring the Fed’s policy rate up to 5.375% as soon as possible and does not rule out supporting a half-percentage-point interest-rate hike at the Fed’s March meeting. The Fed slowed the pace of rate hikes to a quarter-point move at their meeting in early February from a half point in December and a series of four 75 basis-point hikes before that. “It’s not always going to be, you know, 25,” Mester added “As we showed, when the economy calls for it, we can move faster, and we can do bigger at any particular meeting. And it’s going to be driven by how the economy is evolving.” Voting member Philadelphia Fed President Patrick Harker added “It’s going to be above 5% in the Fed funds rate. How much above 5? It’s going to depend a lot on what we’re seeing.”
Inflation Eases, Defies Estimates…U.S. consumer prices rose at an annual pace of 6.4% in January, down from 6.5% annual pace recorded in December. Economists had expected a lower 6.2% annual pace. From a month ago, January consumer prices rose 0.5% higher, relative to smaller price gains of 0.1% and 0.2% in December and November. Energy prices rose 2% on a monthly basis in January, reversing declines posted in December and November. Shelter prices rose at a 0.7% monthly rate, slightly slower than in December. Fed Governor Michelle Bowman explained “The ongoing tightness in the labor market puts upward pressure on inflation, even if some components of inflation moderate due to improvements in supply-side factors.” St. Louis Fed President James Bullard noted “Continued policy-rate increases can help lock in a disinflationary trend during 2023, even with ongoing growth and strong labor markets, by keeping inflation expectations low.”
Detroit Tax Revenue Trends Higher…Detroit has raised its recurring revenue estimate for this fiscal year, and the next one. Higher-than-expected income tax and utility tax have led to the boost. “Despite projections of a mild national recession, the Detroit economy has proven to be more resilient,” Detroit Chief Financial Officer said. With 8,000 new jobs added last year, Detroit’s employment base has surpassed pre-COVID-19 levels. Internet gambling taxes have also kicked in. A $2.5 billion hospital, affordable housing, commercial and retail mixed use project plan could boost the local economy. “Detroit’s revenue recovery and updated actuarial valuations have provided additional financial stability for the city, putting it in a favorable position to tackle upcoming legacy pension contributions,” a Michigan civic organization noted. Since its 2014 bankruptcy exit, Detroit has amassed rainy day funds close to $138 million, and a Retiree Protection Fund worth $460 million. This year, it will seek a sixth one-year waiver from state oversight.
Illinois Budget Boosts Reserves, Pension Funding…A $49.6 billion state spending plan for Fiscal 24 brings scheduled hikes to school aid and sends supplemental funds to rainy day funds and pensions. The Fiscal 24 budget plan puts down $50 million to further pay down Illinois’ bill backlog, which has whittled down to $963 million from $8 billion three years ago. “What was once a state with no cushion to protect it in an economic downturn is now an Illinois on track to have a $2.3 billion rainy-day fund. What was once an Illinois with a credit rating on the verge of junk status is now an Illinois getting credit upgrades.” Governor Pritzker said. Illinois is poised to have a general fund surplus of $303 million by June 2023. Tax collections have outperformed in recent years. Planning for a mild recession, budgeted state revenue is 2.3% lower than the current fiscal year. No tax hikes, fee increases, or significant spending cuts are envisioned. The budget includes a scheduled $350 million increase of school aid. Higher education, human and social services could also see more state funding. Supplemental pension contributions in excess of $9.8 billion statutory funding requirement are proposed. Over the last three years, the lowest-rated U.S. state has won credit upgrades for paying off past due bills and building reserves. “Fiscal responsibility isn’t easy, nor is it a one-time fix,” Pritzker highlighted “It’s an annual effort that requires persistence. It requires conservative. revenue estimates, as all of my budget proposals have.” The proposed budget continues to take Illinois on a path of fiscal progress.
Compare 30-Year taxable U.S. Treasury yield 3.91% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.56%; “AA” 4.02%; “A” 4.51%. 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 91% of comparable taxable U.S. Treasuries.