Municipal Bond News 4/15/24

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Tax-Free Yields Near “Equity-Like Returns” …California Bond Sale…Investors Brace For Fewer Rate Cuts… Bellwether Yields Soar…Atlantic City Upgraded…Detroit Earns Second Investment Grade Rating…Property Taxes Soar…State Migration Trends…

Tax-Free Yields Near “Equity-Like Returns” …An opportunity for locking in higher tax-free income appears to be emerging. Muni bond yields have surged higher in the past 30 days. Current tax-free yields are about 40 basis points higher than at the start of the year. The yield surge follows a jump in bellwether U.S. Treasury yields, as investors reckon with a slower pace of rate cuts. Top-rated muni bonds yield about 4% tax-free, or more than 8% taxable equivalent for top earners in high tax states. Those who missed out on last year’s higher yield levels could find the yield surge noteworthy. After hitting a peak of 4.6% in October 2023, tax-free yields trended lower, and thereafter have remained steady for much of this year. Currently, top-rated muni bonds yield around 3.94% for 30 years. Those looking for an attractive entry point are beginning to take notice of the recent yield surge.

California Bond Sale…$1.5 billion general obligation bonds issued by the State of California last week are front and center. Long-term bonds were issued at a top yield of just over 4% tax-free. Taxable bonds fetched around 5% for ten years, relative to 2.8% for similar dated tax-free bonds. Top earners pay a steep income tax rate of over 50% in the Golden State. The high-grade bond sale came amid a surge in market yields. The yield penalty sought by investors for California tax-free bonds recently surged as high as 17 basis points above top-rated tax-free benchmarks. Last year, California bonds fetched yields that were very similar or even lower than top-rated benchmarks. Facing a large budget deficit, lawmakers recently approved $17 billion of spending cuts.

Investors Brace For Fewer Rate Cuts…From Wall Street to Fed officials, signs of fewer rate cuts are everywhere. Most investors project one or two rate cuts this year. At the start of the year, as many as six rate cuts were the market consensus view. As recently as early March, markets were pricing in three cuts from the Fed in 2024, starting in June. Now, the odds have shifted to the earliest cuts likely in September. A robust U.S. economy and sticky consumer prices led to the shift. “This also implies that less easing of policy this year than previously thought may be warranted,” Boston Federal Reserve president Susan Collins said last week. Goldman Sachs’ chief economist stated that he was “whipsawed” by the “surprising deceleration” in inflation in the second half of 2023, followed by a “surprising re-acceleration” so far this year. Barclays Plc expects just one rate cut this year. Former US Treasury Secretary Lawrence Summers said markets “have to take seriously” the chance the central bank’s “next shift is a hike.”

Bellwether Yields Soar…Last week, the 10-year U.S. Treasury yield hit 4.58% for the first time this year. The 2-year U.S. Treasury yield, which is most sensitive to interest rate policy, exceeded 5% for the first time since last November. The U.S. Treasury bond auction held last week saw the highest auction yield in a decade. A key U.S. price index beat forecasts for the third straight month. Headline annual inflation shot up to 3.5% in March from 3.2% in February, while core inflation held steady at 3.8%. Investors are concerned that instability in the Middle East will drive higher oil prices and contribute to sticky inflation. Slowing U.S. disinflation will keep the Federal Reserve vigilant.

Atlantic City Upgraded…New Jersey’s casino Mecca won a rating upgrade from Moody’s last week. The upgrade from ‘Ba2’ to ‘Ba1’ comes with a positive outlook. Atlantic City, cash- strapped a decade ago, now sits at the cusp of an investment grade rating. Under state oversight since 2016, Atlantic City’s budget management has improved. A structural surplus and lower debt reflect improved finances. While state oversight ends in 2025, Moody’s anticipates that some elements of the current fiscal frameworks will most likely continue. “Governance is therefore a key driver of this rating action,” Moody’s said. Mayor Marty Small said he was seeking a multi-tier upgrade from Moody’s this year, adding “The next upgrade will put us in the investment grade, and I will stop at nothing to make sure we achieve that.”

Detroit Earns Second Investment Grade Rating…Another double-notch rating upgrade has put Detroit firmly into investment-grade territory. S&P raised its Detroit’s General Obligation debt to a ‘BBB’ from ‘BB’, stating, “Ten years on from its bankruptcy filing, Detroit’s financial position and economic condition are the strongest they’ve been in decades.” S&P favorable rating action follows an upgrade from Moody’s last month. “It is a remarkable testament to the City’s efforts that both Moody’s and S&P now rate Detroit as an investment grade credit, made even more significant by the ‘double’-double-notch upgrades.”

Property Taxes Soar…Home price growth, rising public sector wages and inflation have contributed to a larger property tax bill. Local governments collected $363 billion in property taxes from single family homeowners in 2023. That’s almost 7% higher than a year ago, and double the growth rate seen in 2022. New Jersey has the highest property taxes in the nation, with an average real estate bill close to $10,000. 19 of 20 cities with the highest property tax rates are in the Northeast and Midwest. In southern states, booming population is fueling home price appreciation. Florida home prices will likely increase 6%, outpacing up to 3% growth rates for the rest of the United States per Fitch estimates. Real estate gains will boost local governments’ property tax collections.

Migration Trends…In 2023, domestic migration waned. The South was the only region with positive domestic net migration in each of the past three years. Population decreased in eight U.S. states, led by New York. U.S. population has grown slightly but remains below pre- pandemic growth rates. One in five Americans will be age 65 or older by 2030. Florida and North Carolina saw the strongest labor force growth over the past three years. Domestic migration is a large factor for state demographics.

Compare 30-Year taxable U.S. Treasury yield 4.67% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.94%; “AA” 4.08%; “A” 4.33%. For investors in the 35% tax bracket, a 3.8% tax-exempt yield is equivalent to a 5.8% taxable yield.