Municipal Bond News 4/7/25

“Flight to Quality’ Boosts Muni Bonds…Long Muni Bonds Sought…Bellwether Yields Fall…Wall Street Divided… Powell Weighs Tariff Inflation…Muni Sales Forecast Boosted…Chicago Revenue Beats Expectations…Chicago Public Schools Accord With Teachers…

“Flight to Quality’ Boosts Muni Bonds…April has ushered the largest muni bond rally in five months. The rally showcases the ‘haven’ value of state and local government bonds. Long term bond yields fell 20 basis points last week, partly overturning a 40-basis point yield surge in March. A broader rally in comparable U.S. Treasury bonds has led to muni bond price gains. Investors flocked to ‘safe haven’ assets seeking refuge from major stock market losses. Concerns about widespread tariffs have raised the odds of a recession. Like U.S. government bonds, muni bonds are often seen as a haven asset. The average rating of the $4 trillion muni bond market is ‘AA’, the same as the U.S. federal government. The relative stability and resilience of municipal bonds during economic downturns provide protection for investors in times of economic stress.

Long Muni Bonds Sought… Investors are getting compensated more for buying longer dated muni bonds. Benchmark muni yields due in 30 years currently yield around 1.6 percentage points more than two-year debt. The yield gap between shorter and longer-dated muni bonds is the highest since 2021. The steep muni yield curve is drawing investor attention. A portfolio manager told Bloomberg last week “We’re seeing this as a pretty tremendous buying opportunity.” Longer dated muni bonds offer about 7% taxable equivalent yields for top earners. Wealthy individuals in high-tax states like New York and California can buy a 4% coupon tax-exempt bond yielding 4.5% and collect a yield equivalent to 9% on corporate bonds. Unlike corporate bonds, state and local government bonds are ‘haven’ investments.

Bellwether Yields Fall…10-year U.S. Treasury yields fell to 3.9%, the lowest since October and 40-basis point lower than a week ago. Policy sensitive two-year yields fell to the lowest since September 2022. Treasuries have rallied 3.8% this year. State and local government bonds have gained 0.68% this year, underperforming the Treasury rally. Concerns of a global trade war have boosted the value of high-quality fixed income investments. Muni bond yields offer 93% of taxable U.S. Treasury yield, marking the highest ratio since at least November 2023. Relatively higher tax-free yields are attractive to wealthy long-term investors.

Wall Street Divided…The debate on future rate cuts has intensified amid expectations of higher inflation and slower economic growth. While Morgan Stanley now expects no cuts this year (down from one previously), UBS sees more rate cuts this year. Bond markets are assigning higher odds four quarter-point reductions by year-end, with a more than 50% chance of a fifth rate cut, up from just three cuts previously. There are near certain odds of a 25-basis rate cut in June, with chances of a larger rate cut. Additionally, markets are even betting on a chance of a 25-basis point emergency rate cut by next week, ahead of the Fed’s scheduled May 7 meeting.

Powell Weighs Tariff Inflation… “Our obligation is to keep longer-term inflation expectations well anchored and to make certain that a one-time increase in the price level does not become an ongoing inflation problem,” Fed Chair Powell acknowledged that tariffs are “highly likely” to bring at least a temporary rise in inflation. Powell noted that it is also possible that the effects from the tariffs could be “more persistent” depending upon implementation details, the size of economic effects, and how long it takes for tariffs to pass through fully to consumer prices. Powell noted “elevated risks of both higher unemployment and higher inflation” and said the outlook remains uncertain.

Muni Sales Forecast Boosted…In 2025, states and local governments could sell close to $580 billion of new muni bonds, up from $520 billion forecast earlier by Bank of America. The revision comes after an exceptionally strong start to muni bond sales this year, with more than $118 billion issued already, the most in at least a decade. Much of the new offering have been for new infrastructure spending rather than refinancing older debt. However, March issuance was slightly lower than expected due to a sharp rise in yields. Bank of America strategists said “We believe once the market passes the current period of uncertainty, new financing volume should regain the torrid pace.”

Chicago Revenue Beats Expectations…Chicago revenue has surpassed estimates by 7.2% in January and February. City revenue outperformed prior year. Taxes on cloud storage, equipment leases, automobiles, and home sales led to favorable revenue collections. Higher home prices offset fewer sales. However, city officials are cautious about future revenue and uncertain if the recent outperformance will hold through the year. The city is still working to reconcile where revenue stands for 2024 after Chicago Public Schools refused to send a $175 million contribution for non-teaching staff pensions. City administration closed a $1 billion budget deficit this year after enacting several tax hikes.

CPS Accord With Teachers…Chicago Public Schools (‘CPS’) and its teachers union have reached a tentative contract agreement that will cost about $1.5 billion over the next four years. 80% of the contract costs are for 4% to 5% cost of living raises. The unions’ original slate of proposals called for a $10 billion contract that included 9% raises and thousands of new hires. Chicago Teachers Union’s slate of 700 asks from mid-April was whittled to just three sticking points by last week. Chicago Public School CEO Pedro Martinez called the final proposals “sustainable” but confirmed that CPS only had enough money to pay for the first year. The CEO acknowledged the district’s looming “structural deficit” of hundreds of millions, which he said would require more substantial conversations with the city and state. CPS is set to have a new CEO in June.

Compare 30-Year taxable U.S. Treasury yield 4.47% to 30-Year tax-exempt Municipal Bond yield “AAA” 4.11%; “AA” 4.28%; “A” 4.48%. For investors in the 35% tax bracket, a 4.1% tax-exempt yield is equivalent to a 6.3% taxable yield. Top-rated long-term tax-free bonds yield 92% of comparable taxable U.S. Treasuries.