Municipal Bond News 6/12/23

small pattern

Favorable Muni Bond Investment Opportunity…Muni Bond Demand Grows…Seasonal Boost to Muni Bond Returns…Recession Odds…‘Hawkish Rate Hold’ Has Higher Odds…Connecticut Budget Boosts Reserves… Airport Bonds Fly High…

Favorable Muni Bond Investment Opportunity…Higher tax-free yields and relatively attractive tax-free bond prices have brought a favorable point to buy municipal bonds. Benchmark tax-free yields across the muni curve rose in May. Tax-free yields on 10-year muni bonds rose 27 basis points to 2.6%; yields on long-term muni bonds saw increases of about 20 basis points. Long-term tax-free municipal bond yields offer around 93% of taxable U.S. Treasury yields, suggesting value in prices of bonds issued by states and local governments. Higher yields, along with slowing inflation prospects and a federal debt deal, have made muni bonds attractive heading into the summer when seasonal factors tend to boost returns. The seasonal outlook boost comes after May returns showed the worst losses in three decades. Bank of America strategists said, “The muni market should turn around in June as the debt ceiling resolution led to a Treasury rally and a guarded Federal Reserve will likely ensure that inflation continues to decline.”

Muni Bond Demand Grows…Muni fund inflows, a gauge of higher demand, reflect growing investor confidence in the wake of federal debt resolution. Investors added $460 million to municipal bonds last week, after sixteen straight weeks of outflows. Vanguard’s fixed income explained “Last year, the muni market saw record outflows because investors had the unique opportunity to harvest tax-losses. That selling drove an overshoot in valuations to the cheap side. And this was in stark contrast to the fundamental value, which is strong: Over 70% of muni debt is rated ‘AA’ or higher.”

Seasonal Boost to Muni Bond Returns…A summer slowdown in issuance and a surge in bonds maturing at mid-year could boost muni bond returns over the Summer. Muni bondholders will receive cash exceeding $114 billion from coupons, called and maturing bonds over the next four months. Reinvestment needs will top new-issue supply by about $30 billion from June to August. While June often begins softer as investors assess new-issue offerings, late-June through August has historically seen stronger demand, a tailwind for muni bond returns. This year, muni bonds rallied in Jan, March and April, and showed losses in February and May.

Recession Odds…Wall Street is divided on recession prospects. Some money managers believe that conditions are ripe for a recession, while Goldman Sachs has lowered its odds of a recession. “Our base case is for a moderate-to-deep recession — and potentially crises — as the unprecedented pace of global policy tightening seen over the last year starts to really bite,” said an Allianz Global Investors portfolio manager. A credit crunch is a top concern for Fidelity’s investment chief. Tighter lending standards, a persistently inverted U.S. Treasury yield curve, and any rise in unemployment in the coming months is ‘probably a recession signal’ per bond expert Gundlach. Goldman countered that banking stresses will subtract only 0.4% from economic growth this year and that the debt ceiling limit will result in only ‘small spending’ cuts. Goldman Sachs has lowered its probability for a U.S. recession in the next year from 35% to 25%. As markets start to reckon that the recession will be deeper than most think, market yields will begin to fall. Fidelity sees the 10-year Treasury yield falling to 3% by year-end, nearly 75 basis points below the current level.

‘Hawkish Rate Hold’ Gains Odds…The pace of inflation and future fed-funds rate hikes are front and center. Odds favor a pause on policy rates at this week’s Fed meeting, termed a ‘hawkish hold’. Traders have boosted odds of at least a quarter-point rate hike in July. That’s a change from a month earlier, when there was a greater probability of no rate hike, along with a 29% chance of a July rate cut. The Fed will release its updated economic forecast and policy rate projections this week.

Connecticut Budget Boosts Reserves…A $51 billion two-year budget pact, approved by Connecticut lawmakers, plans a $3.3 billion deposit to the state’s rainy day funds. Connecticut will start fiscal 2024, which begins on July 1, with $6.3 billion in reserve or about 28% of annual spending. Supplemental pension contributions are likely, as state law caps reserves to 15% of spending. The budget increases spending by about 7.5% over two years, while staying within the state’s spending cap. Connecticut’s fiscal health has improved to the point where it can afford to provide permanent tax relief, Governor Ned Lamont said. The budget boosts funding for housing, state colleges and universities. Connecticut is cutting a subsidy to the Metropolitan Transportation Authority’s New Haven Line by about $38 million in the first year of the budget to reflect ridership declines, with funding to be restored in the second year of the budget. MTA’s current budget includes a $267 million subsidy payment from Connecticut. Connecticut will end Fiscal 23 this month with a $1.6 billion budget surplus.

Airport Bonds Fly High…Summer airport traffic is expected to show double-digit growth from last year at many airports. Traffic at most airports is near or exceeding pre-pandemic levels. Non-airline revenue such as parking and rental cars has rebounded strongly. Staffing issues and permanent loss in business travel continue to weigh on airport traffic. Liquidity at most airports has soared after massive federal stimulus. Some airports have retained federal relief funds to use over the next year. Separately, lawmakers are working on renewing passenger aircraft and fuel taxes for an additional five years. The aviation taxes contribute to capital improvements at airports. Looking past busy summer travel, a potential economic downturn could weaken air travel. Cost recovery pricing leads airlines to pass on labor rate increases to passengers, potentially softening demand. Airport bonds have outperformed this year.

Compare 30-Year taxable U.S. Treasury yield 3.87% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.59% “AA” 3.92%; “A” 4.24%. 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 93% of comparable taxable U.S. Treasuries.