Municipal Bond News 7/10/23

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Municipal Bonds Oversubscribed…Bellwether Bond Yields Soar… Growing Consensus for More Rate Hikes…New Jersey’s Largest Spending Plan… Puerto Rico’s Consensus Budget…Chicago Seeks Tax Base Growth…U.S. States’ Pension Liability Falls…

Municipal Bonds Oversubscribed…Recent tax-free new muni bond issues have seen large oversubscriptions. Amid strong demand, high-grade Massachusetts general obligation bond sale was upsized, and ‘AAA’ rated Georgia general obligation bonds were repriced at lower yields. “The bond sale was way oversubscribed. We got about $1.2 billion in orders for the fixed-rate piece and were able to use that leverage to negotiate a little bit lower rate and get them all placed,” said Florida Insurance Guaranty Association, which sold new Moody’s ‘A2’/S&P ‘A’ rated tax-free bonds last week. With the summer reinvestment period in full swing, investors are finding attractive tax-free yields and strong credit conditions in the municipal bond market.

Bellwether Bond Yields Soar…Long-term U.S. Treasury yields soared almost 21 basis points from last week. However, state and local government bonds outperformed comparable US Treasury bonds, as tax-free yields fell only 3 to 6 basis points amid a shortage of municipal bonds in the primary market. Most sensitive to policy rate changes, yields on 2-year U.S. Treasuries climbed to the highest in sixteen years. The 2-year U.S. Treasury yield rose as much as 17 basis points to 5.12%, pushing past highs reached in early March. The 10-year U.S. Treasury yield climbed to nearly 4.08%, just short of this year’s peak. The move in bellwether bond yields comes after a spate of better-than-expected economic data has boosted the odds of additional rate hikes in 2023.

Growing Consensus for More Rate Hikes “Almost all” fed officials agreed that more tightening will likely be needed this year, per minutes of the June Fed meeting. “I think more-restrictive monetary policy will be needed to achieve the Federal Open Market Committee’s goals of stable prices and maximum employment,” Federal Reserve Bank of Dallas President Lorie Logan said, However, Atlanta Fed President Raphael, a non-voting Fed member, said “I don’t see as much urgency to move as others, including my chair.” New York Fed President John Williams said he would be data-dependent when deciding the Fed’s next steps, noting that recent economic data showing a stronger-than- expected housing market, resilient growth and a slowdown in consumer spending have been “informative.” Consensus is growing that the Fed will resort to resume raising rates in July after it paused rate hikes in June for the first time in more than a year.

New Jersey’s Largest Spending Plan…In Fiscal 24, New Jersey aims for a surplus, with plans to make full pension payments and pay off debt, although tax collections could be lower. For the third year in a row, the state will fund its full annual pension payment of $7.1 billion while putting away $2 billion toward paying down debt and avoiding new bond issuances. By June 2024, New Jersey expects a surplus of $8 billion, about 15% of budget spending. New Jersey’s tax revenues will collect roughly $2 billion less in taxes in the current and coming fiscal years, but the years of booming revenue will let the state weather the shortfall. State budget experts told lawmakers in May that the looming revenue shortfalls could reduce the state’s surplus from a healthy $10 billion to a still healthy $8 billion. New spending includes a higher subsidy to NJ Transit, larger direct aid to schools, a $300 million boost for hospital capital investment, and tax relief for senior citizens and large corporations. The $54 billion spending plan for Fiscal 24 enacted on July 1 is 10% higher than prior year and is the largest in Garden State history.

Puerto Rico’s Consensus Budget…The federally appointed oversight board and local elected officials arrived at a consensus annual spending plan for the Island on June 30. The budget sets aside $1.1 billion for debt-related spending such as current interest general obligation bonds, sales and use tax contingent value instruments, capital appreciation bonds, and rum cover over CVI. There is also $1 billion allocated for a pension reserve trust. The approval of balanced budgets and the local government’s involvement in their creation is important. PROMESA (‘Puerto Rico Oversight, Management, and Economic Stability Act’) says one of the conditions for the oversight board’s dissolution is the passage of four consecutive balanced budgets.

Chicago Seeks Tax Base Growth…The new administration is looking to issue new tax-free bonds to boost affordable housing and real estate development. Chicago will “work with public/private sectors to increase the size of the city’s tax base and make our tax system more equitable, including by reducing the dependency on property taxes,” the mayor’s office said. Mayor Brandon Johnson spoke of $800 million in new taxes from reinstating a corporate head tax, and hiking taxes on financial and real estate transactions as well as hotels during the election campaign. Initial pension reform proposals will be presented by a working group for consideration by state lawmakers shortly. In 2022, Chicago’s general fund balance grew to $1.3 billion in 2022, almost double prior years’ level. However, the Windy City’s pension liability grew 5% in 2022 from a year earlier due to lack luster investment returns. Recently, Chicago directed surplus funds for supplemental pension contributions. Decades of chronic underfunding helped balloon Chicago’s pension liability, weighing on the city’s budget and credit ratings. A budget proposal for Fiscal 24, which begins on January 1, is expected in September.

U.S. States’ Pension Liability Falls…States and local governments’ aggregate net pension liabilities are on pace to fall a third straight year. U.S. public pension systems could post high single-digit investment returns, Moody’s said. Public pension investment returns have surged in the second half of fiscal year 2023, after lagging below annual targets significantly through the first half. At the same time, higher market rates push down the present value of promised pension payments. Net pension liability is expected to drop 14% from a year ago, and is down 44% from its 2020 peak, Moody’s said. This positive pension funding development will benefit many state and local governments’ credit quality.

Compare 30-Year taxable U.S. Treasury yield 4.07% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.61% “AA” 3.94%; “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 89% of comparable taxable U.S. Treasuries.