Municipal Bond News 5/28/24

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Higher Muni Yields A Silver Lining…Supply Boom A Muni Yield Advantage…Longer Wait For Rate Cuts…BABs Refinancing Wave…Wall Street Mixed on Rate Cuts… Chicago Seeks Higher Rating…Chicago Investor Conference…Airport Funding Boost Credit Positive…

Higher Muni Yields A Silver Lining…Muni bond yields jumped five to fifteen basis points last week. Muni bonds maturing in ten years recorded the biggest weekly climb in yield since March 2020. Muni bond yields rose more than yields on comparable U.S. Treasury bonds. The surge in tax-free yields is driven by a spike in new muni bonds sold by states and local governments. With current muni yields near 2024 highs, long term investors are considering putting cash to work and locking in higher tax- free yield. Potential price appreciation when the Fed begins to cut rates, lower reinvestment risk and tax-free income are advantages of investing in muni bonds relative to staying in cash. For long term investors, higher tax- free yields are a silver lining.

Supply Booms Brings Yield Advantage… An increase in muni bond issuance has led to a sell-off. New muni bond issuances have surged 35% higher than a year ago. Weekly muni bond issuance has crossed $10 billion for seven straight weeks. A rush to borrow ahead of the US presidential election has led to the higher supply. Bracing for higher-for- longer policy rates, states and locals are no longer deferring bond sales. $180 billion muni bonds have been issued this year. Absolute tax-free yields are near the highest in fifteen years, a potential silver lining for investors looking to reinvest about $100 million of principal and interest in the summer months.

Longer Wait For Rate Cuts…“We’re not seeing anything right now that looks like staying here for three or four months is going to cause the economy to go off a cliff,” Fed Reserve Christopher Waller said last week, pointing toward a longer wait for a rate cut. The Fed’s next move is more likely to be a reduction rather than an increase. However, the central bank doesn’t necessarily need to cut interest rates this year if inflation doesn’t decline as much as officials anticipate, Waller said. Atlanta Fed president echoed that monetary policy has been less effective in slowing growth than in previous cycles. Fed officials said they expect to hold policy rates at current levels for longer than previously anticipated.

Build America Bonds Refinancing Wave…An uptick in refinancing Build America Bonds (‘BABs’) will likely continue. A recent court decision clarified that the federal interest subsidy cuts to BAB issuers are a “material change” that could trigger extraordinary mandatory redemption. The U.S. Treasury provides an interest subsidy to states and local governments that issued taxable Direct Pay BABs. Since 2013, the federal interest subsidy has been reduced, an unfavorable development for BAB issuers. To lower exposure to federal subsidy risks and save interest costs, more than two dozen bond issuers have either called BABs or are advancing plans to refinance BABs. To refinance BABs, issuers utilize an “extraordinary redemption provision” triggered by the cut in federal subsidy, a “material event.” About $181 billion Build America Bonds were issued in 2009 and 2010, and about $116 billion were outstanding as of March 2024. New York’s MTA plans to refinance some of its $3.7 billion BABs.

Wall Street Mixed on 2024 Rate Cuts…Goldman Sachs CEO said he’s currently predicting “zero” cuts this year. Meanwhile, Goldman Sachs economists expect two rate cuts in 2024, starting in September, instead of July previously anticipated. Nomura Securities has also pushed its first rate cut call from July to September, saying “the threshold for rate cuts appears to have risen.” In May, U.S. business activity accelerated at the fastest pace in two years. JPMorgan Chase and Citigroup are among the few holdouts still forecasting a July move. Bond markets expect one rate cut by December.

Chicago Seeks Higher Rating…“The ratings don’t really reflect the size and strength Chicago has,” Chicago CFO said last week. Moody’s carries a positive outlook on Chicago general obligation bonds, while S&P and Fitch carry a stable outlook on Chicago general obligation bonds. Chicago general obligation bonds are rated Moody’s ‘Baa3’ S&P ‘BBB+’ Fitch ‘BBB+’. Chicago’s population of 2.7 million and its economic heft were “integral” to Fitch’s upgrade last fall, a Fitch analyst noted. While city pension contributions have risen in recent years, Chicago suspended annual inflation-indexed property tax increases last year, a S&P analyst noted. Chicago bonds are a bellwether for ‘BBB’-rated muni bonds. Investors demand additional yield of 104 basis points for Chicago bonds, down from 173 basis points at the start of the year.

Chicago Investor Conference…Chicago will likely post a surplus this year, city officials said at Chicago’s annual investor conference last week. City administration expects to spend “a lot of money” on O’Hare International Airport, the water system and the parks system, and that there are major investments in Chicago coming from United Airlines. A $1.25 billion bond program for affordable housing and economic development is likely this year. A new Chicago Bears’ stadium, is on the Mayor’s agenda. Furthermore, Chicago’s McCormick convention center is on track to surpass pre-COVID economic impact levels.

Airport Federal Funding Boost Credit Positive…Airports will receive substantially higher federal grants. On May 16, the president signed into law the Federal Aviation Administration reauthorization bill, the FAA Reauthorization Act of 2024. Under the law, capital funding will increase to $4.0 billion annually from $3.35 billion for the next four federal fiscal years. This marks the first increase in yearly capital grant money since fiscal 2012. The higher funding will improve airport infrastructure. Airport infrastructure needs are estimated to be $151 billion for the 2023-2027, up 31% from the prior four-year period. However, the federal funding boost will fall short of airport capital needs, and airports will continue to rely on tax-free bonds to fund infrastructure.

Compare 30-Year taxable U.S. Treasury yield 4.58% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.87%; “AA” 4.12%; “A” 4.26%. 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 84% of comparable taxable U.S. Treasuries.