Municipal Bond News 2/6/23

Disinflation Begins, Powell…25-Basis Point Fed-Funds Rate Hike…Central Banker Views on Future Rate Hikes… Bond Markets Boost Rate Hike Odds…Surprise Job Gains Cloud Outlook… Puerto Rico Tax Collections Outperform… State Budget Season Kicks-Off…MTA Funding Boost Plans…

Disinflation Begins, Powell… “We can now say, I think, for the first time, that the disinflationary process has started,’ Fed Chair Powell explained that disinflation is in an early stage. Goods prices are lower because supply issues have been fixed and shortages have abated. However, services prices are not seeing lower prices yet. Many service costs are driven by upward wage pressures amid strong labor costs, partly offset by lower fuel and goods prices. Powell expects shelter costs to continue to rise, before eventually declining assuming new leases carry softer terms. “I will say that it is gratifying to see the disinflationary process now getting under way, and we continue to get strong labor market data,” Powell acknowledged. Bond markets rallied with the Fed Chairman’s message.

25-Basis Point Fed-Funds Rate Hike…No one was surprised that the Federal Reserve hiked policy rates by 25 basis points last week to between 4.5% and 4.75%. In the last year, the Fed has raised four-and-a-half percentage points from near zero, the highest level since September 2007. After front-loading rate hikes in 2022, the FOMC has now slowed the pace of increases at consecutive meetings. Substantial progress has been made in recent months in the Federal Reserve’s fight against elevated inflation. Higher policy rates have led inflation to decline from 9% in June 2022 to 6.4% at year-end. The Fed noted that while inflation has ‘eased somewhat’, it still remains ‘elevated’.

Central Banker Views on Future Rate Hikes…‘We’re talking about a ‘couple of more rate hikes’ to get to a level of ‘appropriately restrictive’ monetary policy, Fed Chair Powell added that ‘inflation is still running very hot.’ Most prices take some time to adjust to higher interest rates. In March, the Fed will provide its updated forecast of policy rates. When asked about January’s 3.4% unemployment, a 53- year low, non-voting Fed official Mary Daly said that the Fed’s December rate forecasts, which showed a median estimate of about 5.1% at the end of 2023, were “a good indicator of where policy is at least headed. In its ‘fine judgement’ on future rate hikes, Powell said the Fed will be ‘watching the progress of the disinflationary process.’

Bond Markets Boost Rate Hike Odds…Higher odds of at least three quarter-point future rate hikes, in March, May and June, are suggested by futures prices. This is a change from prior market expectations of only one future rate hike in March. Stronger-than-expected jobs growth in January has led the bond market to come to terms with the Federal Reserve’s rate hike forecast. A terminal policy rate higher than 5% this year is likely. Although bond markets predict earlier rate cuts than Federal Reserve estimates, there is agreement that the Federal Reserve is near the end of its rate hike cycle.

Surprise Job Gains Cloud Outlook…The U.S. economy added twice as many jobs in January than forecast. Strong jobs growth appears to be at odds with other signals of the economy. A much less-rosier picture from recent consumer spending, manufacturing and industrial production. The dichotomy raises questions on how long the hiring boom could last. With a slowdown lurking, a likely ‘soft landing’ envisioned by the Fed since last year, is gaining traction.

Puerto Rico Tax Collections Outperform…The Island’s general fund revenues in December are 28% higher than forecast and 14% more than a year ago. For the first half of Fiscal 23, tax revenues are 3% more than a year ago, and 14% higher than projections. Corporate income tax, sales and use tax and individual income tax contribute the most to Puerto Rico general fund revenues. Puerto Rico’s Treasury Secretary stated, “This is important, given that, as a result of the passage of Hurricane Fiona through Puerto Rico, the department implemented a series of administrative measures that postponed several filing dates and payments and, even so, the collections have exceeded what was projected so far.”

State Budget Season Kicks-Off…To craft spending plans for the Fiscal 2024, U.S. state legislation sessions have begun. Amid recession risks, many U.S. states are projecting lower revenue or minimal growth. Inflation has increased state spending on wages, capital plans and aid to downstream governments. Robust reserves are a buffer against headwinds. Florida’s rainy day fund will exceed $15 billion in Fiscal 24 per Governor DeSantis’s budget plan released last week. New York will accelerate deposits to its rainy day fund, which will bring it to about $20 billion, or 15% of state spending. The Empire State’s reserve deposits come two years ahead of schedule. Instead of using its substantial reserves in a downturn, California is opting to trigger spending cuts as needed. The Golden State’s $24 billion rainy day is roughly the size of its projected Fiscal 24 budget shortfall.

MTA Funding Boost Plans…Tax hikes, state and city aid worth almost $1.6 billion annually could be in store for the MTA. Governor Kathy Hochul aims to hike the Payroll Mobility Tax levied on corporations in MTA’s service area. If enacted, the tax hike could generate $800 million to help offset post-COVID-19 ridership decline for the nation’s largest transit system. Additionally, a $300 million boost for the MTA is part of Hochul’s $227 billion New York State Fiscal 24 budget plan. Hochul is calling on New York City to pony up $500 million, but Mayor Eric Adams is not in favor. The MTA is also looking at fare hikes. Down the road, Hochul wants to use casino revenue to support the MTA.

Compare 30-Year taxable U.S. Treasury yield 3.67% to 30-Year tax-exempt muni bond yield “AAA” 3.23%; “AA” 3.69%; “A” 4.09%. 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 88% of comparable taxable U.S. Treasuries.