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Long Term Municipal Bonds Outperform….As expectations build for the Federal Reserve to pause rate hikes, and eventually cut policy rates this year, longer -dated tax-free bonds have outperformed with 4.7% index returns this year. Traders are pricing in almost three-quarter point rate cuts by the end of 2023. The latest inflation readings came in lower than expected. Future inflation expectations are the lowest in the year. There are signs that the labor market is cooling. Investors are also watching for developments in the U.S. debt ceiling. More than a year of aggressive fed-funds rate hikes put interest rates at the highest level since mid-2007.
Tax-Free Reinvestment Needs Soar…With more than $100 billion of muni debt set to mature over the next few months, demand for tax-free reinvestments will soar. Primary market bond issuance will fall short of reinvestment needs. Coupon payments to bondholders will be higher than normal this year, Bank of America strategists said. “Redemptions always exceed issuance, but this year given that supplies are so anemic, the net supply is likely to be more negative than usual,” a Citigroup analyst added. Federal debt policy brinksmanship is causing market volatility, keeping states and local governments away from new debt and capital plans. A higher demand-supply gap is favorable for the muni bond returns. Municipal bond indices have returned close to 3% this year.
Muni Bond Supply Drops…In April, states and local governments sold 24% fewer municipal bonds than a year ago. New muni bonds issued for capital projects have fallen 38% this year, and refunding bond volume is down 44%. Unspent federal aid has reduced borrowing needs. Issuers are staying on the sidelines of the primary market, avoiding market volatility from federal debt ceiling impasse. Texas has claimed the top spot for primary market bond issuance, followed by California, New York, Illinois and Florida. Last month, some U.S. states including California and Illinois issued new general obligation bonds.
Taxable Municipal Bonds Outperform…Taxable bonds issued by states and local governments are outperforming. Index returns on taxable bonds are 5.57% this year, higher than broad municipal bond market 2.47% index returns. Taxable bond issuance is down 70% in 2023, after falling 56% in 2022. Taxable bonds make up about 13% of state and local government bond supply. Foreigners, pension funds and endowments seek taxable municipal bonds, for relatively attractive yields and safety of government payors.
Chicago Board of Ed Outlook Boosted…Moody’s has raised its outlook on Chicago Board of Education, IL (Chicago Public Schools) to positive from stable. The positive outlook reflects a trend of improving net cash and fund balance. The district’s improved cash cushion will help address upcoming challenges, including upcoming labor contract renewals in 2023 and 2024. High pension obligations and enrollment declines are among challenges faced by the speculative grade rated school district. The nation’s third- largest school district was upgraded by S&P in March, and by Moody’s a year ago.
California Budget Gap Grows…California faces a budget shortfall of $32 billion in Fiscal 24, about $9 billion more than estimated in January. The expected shortfall comes on the heels of the sinking fortunes of California’s wealthiest. The top 1% of earners pay about half of California’s personal income taxes. “We are walking into a budget season where we need to maintain prudence,” Governor Newsom warned that a recession could worsen the fiscal situation in coming years. An updated $306 billion Fiscal 24 budget plan utilizes $450 million of safety net reserves. The Governor’s January budget plan had left reserves intact. Newsom said, ‘it’s exactly why that reserve fund was created.’
Illinois Tax Revenue Falters…Weaker-than-expected April tax revenue has led Illinois to lower its revenue forecast for the current fiscal year which ends in June. Illinois tax revenue in April is $1.84 billion lower than a year ago. Illinois expects general funds revenue of $50.7 billion in Fiscal 23, down 1.2% from a February forecast. Lower personal income tax collections have led to the outlook. Governor Pritzker noted, “The good news is that the amount we are talking about is a very small percentage of the overall entire budget, around 1%, and knowing that this might be coming we’ve ramped down some of the spending here and there among agencies to ensure that the revenue drop could be absorbed.”
MTA Congestion Pricing Gets Fed Green Light…The nation’s first congestion pricing plan has been approved by the Federal Highway Administration. After years of delays, MTA can finally move forward with its plan to toll drivers south of 60th Street in Manhattan. A Traffic Mobility Review Board will shape toll rates. A number of U.S. states have implemented High-Occupancy Vehicle lanes with dynamic tolls based upon traffic, but MTA will be the first to charge motorists for driving into its core. London and Singapore have similar plans. The congestion tax is projected to generate $1 billion annual incremental revenue, that will secure $15 billion new municipal bonds, part of MTA’s $55 billion capital plan.
Island’s Tax Enforcement Improves…Technology is allowing Puerto Rico to collect more of levied sales and use tax. In 2022, the government collected 77% of legally liable sales and use tax, up from 61% a decade ago. Tax evasion is a problem in Puerto Rico. From July to January 2023, sales and use tax collections were 1% more than prior year and 12% ahead of forecast.
ESG Investing Debate Takes Federal Stage…A U.S. House Committee held a hearing on the impact of environmental, social and governance-related investment rules on states and local governments. House Republicans and Democrats debated whether ESG-driven investment decisions outperform or underperform market returns. Democrats argued that states like Texas and Florida will see higher borrowing costs and lower pension returns due to their anti-ESG laws. Republicans contended that ESG standards violate consumer rights and federal laws. A few states blamed rating agencies for unfairly relating climate to credit ratings. The congressional hearing, the first of several planned, has taken the partisan debate from the state level to the federal stage.
Compare 30-Year taxable U.S. Treasury yield 3.82% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.44% “AA” 3.86%; “A” 4.19%. 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 90% of comparable taxable U.S. Treasuries.