Municipal Bond News 4/10/23

Municipal Bond Yields Fall…Some Institutional Investors Consider Muni Junk Bonds as Spreads Grow…Job Gains Moderate…NYC GO Bonds Oversubscribed…Detroit Earns Rating Upgrade…Board Proposed PREPA Settlement Seeks to Divide Bondholders…Illinois, Connecticut, and New York Taxpayers Pay Top State and Local Taxes… Municipal Bonds Turn from Biggest Losers to Biggest Winners…

Municipal Bond Yields Fall…Tax-free yields on bonds issued by state and local governments are approaching their lowest levels of 2023. Municipal bond yields have fallen as bellwether 10-year U.S. Treasury yield dipped to 3.29% last week, the lowest since September. A series of economic signals, manufacturing, job openings, and private sector hiring, came in lower than expectations. Tighter financial conditions are beginning to impact businesses and consumers. High interest rates and a pull back in bank lending have led to restrictive financial conditions. The policy-sensitive two-year U.S. Treasury yield dipped from 4.14% to 3.72% during the week on signs of weaker employment. Top-rated municipal bond benchmark yield, 3.23%, is down 40 basis points from early March peak.

Some Institutional Investors Consider Muni Junk Bonds As Spreads Grow…The high yield municipal bond sector is offering the best bargains in almost two years, institutional investors Invesco and Barclays among others believe. Riskier state and government bond yields offer almost 2.4% additional yield relative to top-rated municipal bonds. The yield gap or spread is the highest since early 2021. High yield municipal bonds have gained about 3% this year, right in line with 2.9% returns on top- rated municipal benchmarks. The high-yield muni default rate is roughly 1.2%, per Municipal Market Analytics. The broader muni market last year had a default rate of less than 0.1% per Moody’s, and while it expects more first-time defaults in 2023 “the municipal bond market still represents a very low level of risk.”

Job Gains Moderate…Hiring is gradually cooling, the March jobs report shows. Job gains moderated in March, as employers added 236,000 workers, down from prior month. March job gains are the smallest in more than two years. Wage, which rose 4.2% in March from a year ago, recorded the smallest annual gain since mid-2021 when inflation was surging. Employment is historically strong, as unemployment ticked down to 3.5% in March. More Americans jumped into the labor market in March, easing wage pressures. Hiring was concentrated in a handful of sectors like leisure and hospitality as well as healthcare, which have been struggling with acute labor shortages. Banking system concerns that erupted last month led to concerns about tighter lending conditions, that could ultimately slow the economy and impact hiring. This is the last jobs report before the Federal Reserve’s May 2 meeting, by which time additional inflation readings will also be at hand.

NYC GO Bonds Oversubscribed…Orders worth 2.6x the number of bonds offered by New York City were received last week. Strong investor demand for the GO bonds led to lower than anticipated yields. Tax-exempt high grade GO bonds fetched top-yield of 4.3% for long term tax- free bonds, and about 4.6% for taxable bonds.

Detroit Earns Rating Upgrade…Moody’s has raised Detroit’s general obligation rating to ‘Ba1’ from ‘Ba2’ and assigned a positive outlook. Detroit has moved up to the highest speculative grade rating, which is just notch away from investment grade. Motor City’s strong budget management and economic development led to the upgrade. “While the city’s pension ramp is currently manageable, costs will spike if assets materially underperform, and the city must also contend with other rising cost pressures related to wages and inflation. The city’s leverage and fixed-costs ratios are in line with other big cities,” Moody’s said. ‘Our goal is to have an investment grade rating restored,” city CFO said. Detroit lost its investment grade rating in 2009. In 2014, it emerged from bankruptcy protection, and state oversight ended in 2017. A state review commission continues to monitor Detroit’s finances. Mayor Mike Duggan stated, “Going from bankruptcy and state financial oversight to being within striking distance of an investment grade rating in less than 10 years is a tremendous accomplishment.”

Board Proposed PREPA Settlement Seeks To Divide Bondholders…An overwhelming 90% of PREPA bondholders have rejected the oversight board’s proposed settlement offer. The bond trustee is also opposed to the oversight board proposed debt plan which seeks to divide bondholders based upon their response to the board’s settlement offer. The Bond Trustee for Puerto Rico electric utility bonds and the majority bondholder group intend to oppose the oversight board proposed debt plan and seek to appeal the Title III Court’s summary judgement order. The summary judgement order limits bondholder security to relatively small sums of money relative to the bond trustee’s secured bankruptcy claim. Faced with a deeply contested debt plan, Judge Swain has urged the parties to mediate a consensual agreement. So far, mediation has not been fruitful. Judge Swain seeks confirmation hearings on Puerto Rico electric utility debt in mid-July.

Illinois, Connecticut, and New York Taxpayers Pay Top State and Local Taxes…The average U.S. household pays $11,000 in federal taxes each year. In addition, a gamut of state and local taxes take a chunk out of taxpayer’s wallets. State income tax, property tax, vehicle tax and sales tax are the largest taxes levied by U.S. states. Tax policies vary across U.S. states. Illinois taxpayers pay the highest effective tax rate exceeding 15%, which includes state income tax and property tax rate as a share of annual median income, per WalletHub. Connecticut is in second place, with an effective tax rate of 14.8%, closely followed by New York at 14.2%. New Jersey’s effective state and local tax for the median household income level is almost 13%. Tax-free bonds issued by high-tax states are much sought.

Municipal Bonds Turn from Biggest Losers to Biggest Winners…Top-rated municipal bond indices have gained 3.7% this year. 2023 bond price gains come after municipal bond indices lost 8.5% last year, the worst showing in several decades. Municipal bonds have started the second quarter of 2023 on a strong note, with tax- free bonds returns close to 1% so far in April. Municipal bond returns grew 2% in March, the strongest March performance since 2008. Municipal bonds also rallied in January with a 2.8% monthly return. In February, municipal bond prices fell as stronger-than-expected economic data fueled steep rate hike fears. Those fears were overturned last month when the Federal Reserve changed its guidance upon banking system concerns. This years’ municipal bond price gains are paring last years’ losses. Investors reckon that the Federal Reserve is closer to end of its rate hike cycle.

Compare 30-Year taxable U.S. Treasury yield 3.59% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.23%; “AA” 3.60%; “A” 4.1%. For investors in the 35% tax-bracket, a 3.5% tax-exempt yield is equivalent to a 5.38% taxable yield. Top-rated long-term tax-free bonds yield 90% of comparable taxable U.S. Treasuries.