Municipal Bond News 6/3/24

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Investors Eye High Muni Bond Yields…High Yield Muni Bonds Outperform…Illinois Bonds Rally…Bellwether Yields Drop…Assured Guaranty Earns S&P Praise…Connecticut Earns Positive Outlooks…California Revenue Underperforms…Colleges Borrow Big

Investors Eye High Muni Bond Yields…Tax-free yields are currently at their highest levels since November. Muni bond yields have surged 15 basis points over the past two weeks. Muni bonds have posted losses for two straight months. In May, muni bond indices posted a 0.3% loss while comparable U.S. Treasury bonds gained 1%. A surge in state and local government borrowing has caused muni bonds to underperform comparable U.S. Treasuries. May muni bond issuance soared 47% from a year ago, the highest monthly primary market volume in eight years. This week, over $14 billion muni bonds are expected to be sold, the highest since 2017. Barclays strategists noted “We think this might actually present a tactical buying opportunity, as supply might be light during the FOMC week and the holiday -shortened week after that.”

High Yield Muni Bonds Outperform…Despite the sell-off that erased earlier gains in broad muni bond indices, high yield muni bond indices have gained 1.6% this year. “As typically happens in rapid selloffs, lower-rated bonds have outperformed and their spreads might continue compressing,” a Barclays strategist said. Specifically, high yield water, sewer and transportation bonds have outperformed with year-to-date gains above 3.5%. Institutional demand for muni bonds is recovering this year. There have been positive cash inflows to both investment grade and high yield bond funds in 2024, a contrast from redemptions or outflows in the prior two years. Despite a surge in primary market issuance, new tax-free issues are heavily oversubscribed.

Illinois Bonds Rally on Budget…Illinois’ election year spending plan, $53.1 billion, is the highest in history. The spending plan passed 60-47, with seven Democrats joining Republicans in opposition, the slimmest approval in several years. A $1.1 billion revenue boost from progressive taxes on sports wagering, caps on retailers’ sales tax credits and corporate net operating loss deductions is notable. A $350 million increase for elementary and secondary education, as required by a 2017 school-funding overhaul, will boost state school spending. Public pensions will receive legally required contributions of about $10 billion. The budget veers away from public funding for a new Chicago Bears stadium, and provides $182 million for migrant care. An on- time budget and broad improvement in finances have cheered bondholders. The yield penalty on Illinois bonds has shrunk to about 62 basis points, down from 95 basis points at the start of 2024, and 440 basis points in 2020.

Bellwether Yields Drop…U.S. government bonds rallied Friday, adding to their monthly gain. The 10-year note’s yield fell below 4.5% Friday after peaking above 4.63% this week. Treasury yields declined at least five basis points. Gross domestic product rose 1.3% annualized in the first three months of the year, below the previous estimate of 1.6%. The Federal Reserve’s preferred measure of underlying US inflation moderated in April and consumers dialed back spending, supporting plans for an eventual reduction in interest rates. Current long term muni bonds yield 87% of taxable Treasury yields, up from 81% in January 2024.

Assured Guaranty Earns Accolades…The largest bond insurer, Assured Guaranty, carries “excellent capital adequacy”, “excellent capital and earnings”, and “exceptional” liquidity, S&P highlighted last week. “Assured Guaranty’s AA rating affirmation by S&P highlights our ‘strong presence in the U.S. public finance market’ and our ‘measured approach to insuring non-U.S. public finance transactions,’ Assured Guaranty CEO added, “Assured Guaranty is poised to continue growing its insured portfolio to sustain and increase its store of unearned premiums, its future earnings power and its financial strength. Assured Guaranty continues to offer a uniquely beneficial value proposition to both issuers and fixed income investors.”

Connecticut Earns Two Positive Outlooks…Moody’s and Fitch raised their outlooks on Connecticut to positive from stable last week. Connecticut is rated ‘AA-’ by Fitch, ‘Aa3’ by Moody’s and ‘AA-’ by S&P, the fourth-highest ratings. Connecticut’s “renewed commitment to budgetary guardrails that constrain expenditure growth” won accolades by Fitch. If state officials adhere to those policies, Connecticut is expected to maintain solid reserve levels and further reduce leverage metrics, Moody’s said. Connecticut revenue is likely to grow over the next four fiscal years. Connecticut has earned several credit upgrades since 2021. Welcoming the favorable rating actions, Governor Ned Lamont said, “Once again, investors are taking note of the significant progress Connecticut continues to make to grow our economy and reduce our fixed cost growth.”

California Revenue Underperforms…California revenues are underperforming despite a strong national economy. Since mid-2022, California has lagged the rest of the US on key metrics, such as growth in employment and income. General fund revenue in 2024 is down about 17% compared to 2022. Fiscal 2024 revenue are likely to be $8 billion lower than the state had projected in January, widening the state’s budget gap. California is expected to draw about $29 billion from rainy day funds in the current fiscal year. In Fiscal 2025, Governor Newsom proposes $25 billion in spending cuts or deferrals. The state’s multi-year general fund forecast assumes further budget deficits beyond fiscal 2026, implying that the Golden State reserves could potentially diminish.

Colleges Borrow Big…Muni bond issuance by colleges has surged to the highest in almost a decade. This year, colleges have issued nearly $10 billion of new muni bonds. The list of college borrowers this year is long and varied. Sprucing up campuses and refinancing costly prior debt are college priorities. Faced with fewer high school graduates, colleges are trying to differentiate themselves by building sports facilities, upgraded student housing, events space and career centers. “As you participate in this arms race, you want to make sure that you’re using that debt really wisely,” a college CFO said. The increased borrowing could raise already-high tuition costs. Many colleges have also taken advantage of favorable market yields to refinance their debt.

Compare 30-Year taxable U.S. Treasury yield 4.61% to 30-Year tax-exempt Municipal Bond yield “AAA” 4.00%; “AA” 4.23%; “A” 4.44%. 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 87% of comparable taxable U.S. Treasuries.