Municipal Bond News 5/27/25

Tax-Free Bond Yield Advantage Lures Investors…Muni Bond Credit Quality Resilient…Muni Credit Rating Upgrades Surpass… Bellwether Yields Surge…Central Bankers ‘Wait-and-See’…Chicago Seeks Revenue Fix…Chicago Public Schools Mulls Refi…U.S. State Revenue Sluggish…U.S. House Approves SALT Cap Hike…

Muni Bond Yield Advantage Lures Investors…Demand for municipal bonds surged last week. Investors poured over a billion dollars into state and local government bonds, the highest amount since the end of February. High net worth investors can currently earn more than 200 basis points of additional yield compared to comparable U.S. Treasuries by investing in state and local government bonds. A diverse range of local governments, airports, and colleges featured prominently in last week’s primary market. For instance, an airport in Charlotte, North Carolina, issued high-grade municipal bonds with a top tax-free yield of 4.7%. Additionally, a convention center in New Orleans, Louisiana, sold high-grade bonds at a top yield of 5%. This week, less than $4 billion in new municipal bonds is expected to be issued.

Muni Bond Credit Quality Resilient…Most muni market issuers are unaffected by Moody’s’ recent downgrade of the United States credit rating to ‘Aa1’ from ‘Aaa’. States are sovereign entities, and nearly every U.S. state has some form of balanced budget requirement, often mandated by their constitutions. The ability of local governments to raise revenue is determined by state laws, voter decisions, and local regulations, rather than by the U.S. government. Taxes serve as the primary revenue source for U.S. states, although federal funding is also significant. However, certain federally funded programs, such as disaster recovery funding, higher education, low-income housing, and healthcare, are indirectly tied to the United States’ credit rating. That said, the credit strengths of higher-rated municipal issuers help mitigate the impact of such federal linkages. Overall, the federal government exposure is low for the majority of U.S. public finance issuers. Approximately a dozen top-rated states, including Florida and North Carolina, along with hundreds of municipalities such as Boston and Fort Lauderdale, hold credit ratings that exceed that of the United States.

Muni Bond Credit Rating Upgrades Surpass…Muni bond ratings remained largely stable in the first quarter of 2025. Moody’s credit ratings upgrades continued to outpace downgrades by a wide margin. However, unfavorable outlook changes exceeded favorable ones for the first time since the pandemic. Credits associated with the Southern California wildfires and higher education accounted for the majority of unfavorable rating actions. The charter school sector saw a near-even mix of rating upgrades and downgrades. Local governments led the way for upgrades, showcasing the resilience of the sector.

Bellwether Yields Surge…Long term U.S. Treasury yields climbed to 5.15% last week, marking the highest level in nearly 20 years. Longer-dated risk-free bonds yield about 1% higher than shorter maturities, the largest gap since 2014. Concerns about the federal budget deficit have prompted investors to seek greater compensation for holding longer-term bonds. Long-term state and local government tax-free bonds yield 91% of comparable U.S. treasury bonds.

Central Bankers ‘Wait-and-See’…Fed officials are taking a cautious approach to future rate cuts due to ongoing uncertainty. “We’re in center position,” San Francisco Fed president Mary Daly added “My reaction function is to stay in center position and be prepared to move agilely, but not abruptly or quickly when we don’t need to, because we don’t have enough information to really bring those confidence bands in.” Cleveland Fed president Beth Hammack echoed, “I think the best action we can take is to sit on our hands.”

Chicago Seeks Revenue Solutions…Chicago is evaluating various recurring revenue streams to address looming budget gaps. The city’s reliance on one-time solutions resulted in S&P downgrading its credit earlier this year. Budgets gap in each of the next two years are forecast to top $1 billion. Additionally, Chicago has engaged Ernst & Young to help find cost efficiencies in government operations. A newly appointed working group including large corporations such as Microsoft, Alphabet, civic groups and lawmakers will make recommendations to improve Chicago’s long-term financial stability. “All those things are going to inform the proposal this administration ultimately makes for the budget,” Chicago CFO said at a recent investor conference “We are committed to not going to “scoop and toss” debt restructuring.

Chicago Public Schools Mulls Refinancing…New Chicago Board of Education bonds are likely to be issued in the primary market this summer. The junk-rated school district plans to refinance up to $1.8 billion bonds and finance $650 million of capital expenses. The nation’s third largest school district stands to save up to $100 million from the refinancing. Meanwhile, next years’ budget deficit is likely to be at least $229 million per the school’s budget proposal. The school’s outgoing CEO said, “We know we can balance the budget without raising taxes and without irresponsible borrowing.”

U.S. State Revenues Sluggish…U.S. state tax revenue continued to show sluggish growth in the first quarter of 2025. 29 U.S. states showed year-over-year gains, while 17 states saw declines. Nationally, personal income tax collection rose 9.5% nationwide in the first quarter of 2025; corporate income tax revenue rose 4.8% and state general sales tax revenue grew 2% from a year ago. State revenues have become increasingly volatile since the pandemic. Initially, there was a surge in tax revenue, driven by federal pandemic aid. However, revenues fell in 2023 and 2024 owing to stock market fluctuations and widespread personal income tax cuts. Looking ahead, federal policy shifts and tax reform will force U.S. states to reassess budget priorities.

U.S. House Approves SALT Cap Hike…The U.S. House of Representatives approved a $40,000 cap on state and local government tax deductions for taxpayers earning up to $500,000. The SALT cap has divided lawmakers by state and political lines. The bill now heads to the Senate, which aims to finalize by July 4^th. If enacted, this tax reform bill is projected to increase the federal budget deficit by $2.7 trillion by 2034.

Compare 30-Year taxable U.S. Treasury yield 4.97% to 30-Year tax-exempt Municipal Bond yield “AAA” 4.57%; “AA” 4.91%; “A” 5.11%. For investors in the 35% tax bracket, a 4.6% tax-exempt yield is equivalent to a 7.08% taxable yield. Top-rated long-term tax-free bonds yield 92% of comparable taxable U.S. Treasuries.