Municipal Bond News 6/26/23

Long-Term Muni Bonds Biggest Winners…Powell Eyes One or Two More 2023 Rate Hikes…Toll Roads’ Credit Quality Resilient…U.S. States Boost Transportation Funding… Chicago Casino Advances…Puerto Rico Financial Reporting Improves…U.S. State Revenue Slower…Vacant Offices Could Weigh on Large Cities…

Long-Term Municipal Bonds Biggest Winners…Longer-dated municipal bonds have delivered close to 5% index returns this year, almost double the overall municipal bond benchmark return. Longer-dated muni bonds carry higher yields, and they stand to outperform when a recession looms. Moreover, longer-dated maturities of state and local government bonds carry higher yields relative to shorter-dated bonds, which distinguishes municipal bonds from comparable U.S. Treasury bonds in the current market environment. At present, longer-dated Treasury bonds are yielding lower than shorter maturities, known as an inverted yield curve. Last week, the U.S. Treasury yield curve saw this inversion grow deeper, a sign of a looming recession. The Fed warned of additional rate hikes this year, although it kept rates unchanged at its June meeting. CNBC said last week, “Municipal bonds can offer your portfolio tax-free income and stability as recession fears loom.” A gauge of investor demand, inflows to funds, showed that investors added cash to municipal bonds last week, with the majority being long term muni bond investments. Prices of long term muni bonds are attractive, with 30-year top-rated municipal bond yields at 94% of comparable U.S. Treasury yield. Betting that longer-dated bond prices will gain when an economic slowdown prompts the Fed to cut rates, investors are buying longer dated muni bonds to lock in higher tax-free yields.

Powell Eyes One or Two More 2023 Rate Hikes…Fed Chair Powell told lawmakers that “it will be appropriate to raise rates again this year, and perhaps twice,” if the economy performs about as expected, even as they’ve been hiked to an appropriately restrictive level. Powell added “Given how far we’ve come, it may make sense to move rates higher but do so at a more moderate pace.” Central bankers are divided on additional rate hikes in 2023. Fed Reserve Governor Michelle Bowman believes additional policy-rate increases will be necessary to bring inflation down to our target over time, while Atlanta Fed President Raphael Bostic supports holding rates steady to allow for steep rate hikes to take effect. Traders raised odds of a 25 basis point rate hike in July, and trimmed bets on any rate cuts this year.

Toll Roads’ Credit Quality Resilient…Toll road traffic generally surpassed pre- pandemic levels in 2021. However, new traffic patterns have settled in post- COVID-19. Telecommuting has led to lower passenger traffic on major toll roads in the north-east, while leisure and commercial traffic has outpaced. In Florida and Texas, toll road traffic has boomed with stellar population growth in southern states between 2020 and 2022. Recession prospects and regional economies play a role in toll road traffic, as do gas prices. Fitch said that it does not anticipate rating actions from a potential mild recession in 2023. Lower gas prices, relative to last year, stand to boost leisure travel. An upswing in traffic going into the summer months bodes well for U.S. toll roads.

U.S. States Boost Transportation Funding…State funding for transportation infrastructure is trending higher. U.S. states have approved $13.5 billion worth of new investments for transportation this year, relative to $15 billion in all of last year. Strong budget surpluses in many states have led to a surge in one -time funding for transportation projects. Florida recently transferred $4 billion from its general fund for 20 transportation projects to address congestion. Many funding measures feature new municipal bonds.

Chicago Casino Advances…The Illinois Gaming Board voted unanimously to approve ‘preliminary suitability’ for Bally’s to operate a Chicago casino. The vote is the first in a series as the state regulator reviews various parts of Bally’s $1.7 billion proposal to build a casino complex. Chicago City Council approved Bally’s proposal in May 2022 but the project needs state approval to move forward. “The ruling will enable us to continue development efforts on Bally’s Chicago Casino temporary site, Bally’s said. A temporary site is expected to open later this year. The permanent casino, Chicago’s first, will include 4,000 gaming positions, and will be part of an entertainment complex comprising hotels, convention space and a theater. Casino taxes will help shore city police pensions.

Puerto Rico Financial Reporting Improves…The Island’s administrative capacity has improved, Fitch noted. Puerto Rico audit releases have been much delayed. 2019 and 2020 audits were released in 2022. However, some financial reporting improvements are underway. Recently, the Commonwealth released its 2021 audit, and the 2022 audit is expected in a few months. States and local governments usually provide audits within six months after the fiscal year closes. Post-PROMESA reforms such as stronger budgetary policies, modernization of financial collection and reporting systems, and stronger internal controls have helped improved financial reporting timelines. Fitch noted, “Together these initiatives greatly bolster transparency and accountability, allowing external parties greater insight into major factors of the commonwealth’s credit quality.”

U.S. State Revenues Slower…After two straight years of double-digit growth rates, U.S. state revenue is poised to decrease amid weaker overall economic growth. From record highs set in 2022, states’ aggregate general fund revenue is expected to decrease 0.3 percent in fiscal 2023, and could decline by another 0.7 percent in fiscal 2024, per National State Budget Officers Association. State spending growth will moderate in 2024, ending two years’ of fast paced spending. Notably, 45 U.S. states’ general fund revenue exceeded budget estimates in Fiscal 2023. 39 states are on track to further increase the size of their rainy-day fund balances in fiscal 2023. 13 U.S. states and Puerto Rico begin Fiscal 2024 on June 30.

Vacant Offices Could Weigh on Large Cities…Large U.S. cities are bracing for potential revenue losses as office real estate valuations have lost close to 40% nationwide post-COVID-19. With offices in large cities half-empty, a mix of city revenue ranging from property tax, sales tax and payroll tax are adversely impacted. However, residential real estate, which makes up 60% of large cities’ tax base, has seen valuations rise. Amid emigration and home affordability concerns, political pressures oppose shifting the tax burden to residential property owners. With plenty of options, large cities are already planning ahead and working to reinvigorate half-empty downtowns. Los Angeles has imposed a tax on home sales above $5 million. New York Mayor Eric Adams is looking at two state-approved casinos. New York City’s projected property tax revenue could be $1.12 billion short in 2027. “While not a small amount, it is well within the range in which tax revenues can ordinarily vary,” NYC comptroller said of the shortfall, which equates to about 3% of city’s total property tax collection.

Compare 30-Year taxable U.S. Treasury yield 3.77% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.56% “AA” 3.82%; “A” 4.13%. 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 94% of comparable taxable U.S. Treasuries.