Municipal Bond News 4/17/23

Rate Rally Clarifies Value in Municipal Bonds…Muted Tax-Season Impact on Municipal Bonds…Fed Officials Mull Rates…New Jersey Earns Third Rating Upgrade in A Week…MUDs Benefit From Tax Base Growth…U.S. States’ Revenue Dimmer…Bank Concerns To Dampen U.S. GDP Growth, Says IMF…Fed Sees Mild 2023 Recession…

Rate Rally Clarifies Value in Municipal Bonds…Municipal bonds have rallied so far this year. Top-rated long-term municipal bond yields have dropped about 50 basis points over the last month. Yields on some state and local government debt have dropped close to 75 basis points. The most prevalent coupon rates for tax-free bonds are 3%, 4% and 5%. Investors pay a premium for 5% coupon bonds as the coupon income is higher than current market interest rates. On the other hand, investors pay less than par, or a discount price, for 3% long term coupon bonds. The question now becomes which coupon structures: premium, par, or discount, offer the most value to investors. A Municipal Bond Specialist can help understand the value proposition of various coupon structures.

Muted Tax-Season Impact on Municipal Bonds…The municipal bond market didn’t see its usual tax season under-performance because investors had fewer 2022 capital gains and abundant taxable money market holdings, Bank of America strategists said. In the second quarter of 2023, municipal bondholders will receive $142 billion from principal and coupon redemptions, outnumbering expected new bond issuance of $106 billion. BofA said “While tightening bank lending is a concern for economic performance later this year, economic data released over the past few weeks especially the March employment report continue to show a picture of resilience.”

Fed Officials Mull Rates…Atlanta Fed President Raphael Bostic called for one more increase and then a hold. Central bank Governor Christopher Waller said in a speech that he favors more tightening to curb high inflation. Fed Governor Christopher Waller said that ‘monetary policy needs to be tightened further.’ “How much further will depend on incoming data on inflation, the real economy, and the extend of tightening conditions,” Waller explained. San Francisco Fed President Mary Daly said that there are ‘good reasons to think that the economy may continue to slow, even without additional policy adjustments.’ Chicago Fed President Austan Goolsbee wants the Fed should exercise ‘prudence and patience’ in raising rates. Traders assign four in five odds of a 25-basis point rate hike in May.

New Jersey Earns Third Rating Upgrade in A Week…Both Fitch and S&P upgraded New Jersey general obligation bonds last week. S&P upgraded its rating on New Jersey’s general obligation bonds to ‘A’ from ‘A-‘, the state’s third credit rating upgrade in less than a week. Fitch raised New Jersey’s issuer rating to ‘A+’ from ‘A.’ S&P and Fitch upgrades comes just days after Moody’s upgraded the state’s rating to ‘A1’ from ‘A2’. New Jersey State Treasurer said “It’s more clear than ever that the moves we’ve made to pay down our debt, increase our surplus, and make our required pension payments are paying off.” Governor Phil Murphy said “Today’s upgrade from S&P is welcome news coming as it does on the heels of the announcements from Fitch and Moody’s and is just more evidence that New Jersey is on the right fiscal path.” In just over a year, New Jersey has earned six ratings upgrades.

MUDs Benefit From Tax Base Growth…All Texas MUDs benefited from strong property value growth in Fiscal 2023. General fund reserves increased sector-wide in fiscal 2023. Property valuation for most MUDs rose 10% in 2022 from a year ago, while Moody’s ‘Baa3’-rated MUD property value shot up by 42%. Lower- rated MUDs tend to be growing, with development funded with debt. In contrast, high-grade MUDs are typically near full development. Median debt service costs and debt burden tends to be higher for lower-rated MUDs relative to top-rated peers. Continued growth in property values, fueled by strong 2022 population growth in Texas, has benefited the MUD sector. MUD revenue will likely continue to increase in the near term, bolstering reserves. A Municipal Bond Specialist has the expertise to select tax-free MUD investments for a diversified tax-free bond portfolio. For latest Moody’s report on Texas MUDs, please contact your GMS Account Executive.

U.S. States’ Revenue Dimmer…Some U.S. states face a dimmer revenue outlook this year. In New York State, personal income tax revenue plummeted by $9.1 billion between April 2022 and January 2023, the first 10 months of the state’s fiscal year, NYS Comptroller reported last month. In January 2022, New York projected a cumulative budget surplus of $17.3 billion over the next three years. But the new report projects a cumulative deficit of $22.2 billion in the next three years. California faces a $24 billion budget deficit in Fiscal 24, as revenues are lower than projected. Spending cuts/deferrals are under consideration. A slower economy and tax breaks to lower tax-bracket earners has led some tax revenues to underperform. However, aggregate state sales tax revenue has increased 4.5% in January from a year ago. Accordingly, states that rely heavily on sales taxes have benefited from the surge. After two years of record tax collections, some U.S. states face a new economic reality.

Bank Concerns To Dampen U.S. GDP Growth…A decline in lending will cut 0.44% off U.S. GDP growth in 2023. The IMF forecasts the U.S. economy to grow 1.6% in 2023, down from 2.1% a year ago. U.S. banks’ lending capacity will decline by 1% this year. Investors, regulators and lawmakers have put banks under a microscope, causing bank stocks to fall. Some banks may be inclined to stockpile cash faced with increased scrutiny and volatility, which could lead to a credit crunch. The IMF said, “Because regional and smaller banks in the United States account for more than one-third of total bank lending, a retrenchment from credit provision could have a material impact on economic growth and financial stability.” Fed Chair Powell is also watching for any signs of a pullback in lending that slows the economy, which would imply that the Federal Reserve would not have to raise rates as much.

Mild 2023 Recession…Several central bankers wanted to pause rate hikes in light of banking system concerns, but relented to a quarter-point rate hike last month. Recent developments in the banking sector are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation, Fed Minutes released last week said. A new borrowing facility for banks and easier conditions for emergency loans for banks helped ease banking sector concerns. “Even with the actions, participants recognized that there was significant uncertainty as to how those conditions would evolve,” the minutes said. Fed officials expect a ‘mild recession starting later this year, with a recovery over the subsequent two years.” Fed Minutes noted that in 2024 and 2025, both total and core PCE price inflation are expected to be near 2 percent.

Compare 30-Year taxable U.S. Treasury yield 3.76% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.21% “AA” 3.67%; “A” 4.06%. 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 85% of comparable taxable U.S. Treasuries.