Municipal Bond News 7/22/24

New Detroit Bonds Draw Strong Investor Interest…Mega Muni Bond Sales Oversubscribed…Muni Bond Demand Grows…Central Bankers Push For Rate Cut…U.S. State Spending Cuts…Pension Funding Improves…Climate Risks Challenge Disaster Relief…

New Detroit Bonds Draw Strong Investor Interest…Motor City’s first bond sale as an investment grade-rated issuer attracted strong bids and lower credit spreads. Competing bids came from 13 Wall Street firms for Detroit’s $ 46 billion bond sale. This is the first competitive bond auction for the city since its 2014 bankruptcy exit. Detroit received double notch upgrades from Moody’s and S&P this year. Moody’s raised its rating to ‘Baa2’ from ‘Ba1’ with a positive outlook in March, following S&P’s upgrade from ‘BB+’ to ‘BBB’. Improved ratings returned Detroit to investment grade status for the first time since 2009. Reflecting the improved credit quality of Motor City, the yield penalty on the new unlimited tax general obligation bonds ranged from 36 to 76 basis points. By comparison, a 2023 Detroit bond offering saw higher credit spreads between 138 to 178 basis points. Detroit CFO said “Today marks another milestone for the City of Detroit as we successfully completed our first competitive bond issuance.”

Mega Muni Bond Sales Oversubscribed…The largest sale in the New York City Transitional Finance Authority’s history drew orders worth 2.7x the amount of bonds offered. The New York City Transitional Finance Authority sold $2 billion high grade tax-free bonds with a top yield of 3.5% for bonds maturing in 2041or 35 basis points above top-rated muni indices. Strong demand led the issuer to upsize the bonds, which repriced to lower yields. New York, California and Florida issuers sold billion-dollar range tax -free bonds last week. Miami International Airport sold $923 million tax-free bonds rated S&P/Fitch ‘A+’ with 3.85% yield for bonds maturing in twelve years. University of California Regents sold $934 million tax-free bonds with a top yield of 3.75% for 30-year bonds. Despite a heavy bond sale calendar, muni bond yields remained similar to prior week levels. Issuers are benefiting from robust demand for muni bonds.

Muni Bond Demand Grows…The outlook for state and local government bonds is improving as demand for muni bonds has grown sharply this month. For three straight weeks, investors have ramped up purchases of muni bond funds. Inflows to bond funds are a gauge of investor demand. In the last week alone, investors added about $900 million to muni bond funds focused on U.S. state and city debt in the past week, marking the highest inflow since May. High yield tax-free bonds attracted about 40% of the demand. About $2.3 billion of cash has been invested in muni bond funds this year, a notable shift from the significant outflows in the previous two years. Growing confidence among investors that the Fed will cut rates this year is fueling demand for muni bonds.

Central Bankers Push For Rate Cut…Fed officials are looking to lower borrowing costs soon to address unemployment, which has risen for three straight months. The Fed’s preferred inflation gauge has eased to 2.6% recently. “I do believe we are getting closer to the time when a cut in the policy rate is warranted,” Fed Governor Christopher Waller added that the labor market is in a “sweet spot,” he said, but the Fed needs to keep it there. Richmond Fed President Thomas Barkin is encouraged by recent disinflation but is looking for more evidence that it will be sustained. Chicago Fed President Austan Goolsbee noted that the Fed risks the ‘golden path’ of curbing inflation and maintaining solid employment if it does not cut soon. New York Fed President John Williams said that underlying trends that supported low rates pre-pandemic “are still very much intact.”

Pension Funding Improves… National public pension funding shortfall will drop to $1.3 trillion from $1.6 trillion in 2023 per the Equable Institute. Record high contributions by state and local governments has improved public pension system’s funded ratios. On average, the funded ratio of public pensions will increase to nearly 81% from about 76%. Strong investment returns have boosted pension assets. Most state and local government pension systems posted double-digit returns of about 11% for the fiscal year ended June 2024, per Moody’s. For four straight years, unfunded pension liabilities have fallen. Public pension funds’ unfunded liabilities have fallen by more than $3 trillion, or about 60% since peaking in 2020 per Moody’s. This decline in pension fund liabilities can be attributed to high interest rates driving down the present value of accrued benefits. Furthermore, most governments’ annual pension contributions are broadly deemed sufficient to prevent unfunded pension liabilities from growing.

U.S. State Spending Cuts…U.S. state spending cuts are expected in Fiscal 2025. In Fiscal 24, U.S. state aggregate general fund spending rose to $1.3 trillion, a 13% increase from the prior year. That is set to change in Fiscal 25. Total U.S. state spending is expected to drop 6% from Fiscal 25. The decline in spending is comparable to the declines in 2009 and 2010, when the Great Recession drove state spending down by 5.8% and 6.6%. However, not all U.S. states are cutting budgets. About half of U.S. states are still planning budget increases in 2025. Vast cuts to close California’s $46.8 billion Fiscal 25 budget deficit impacted the 50-state aggregate spending picture. The era of post-pandemic revenue outperformance, record high spending, and historic tax cuts is coming to an end.

Climate Risks Challenge Disaster Relief…Since it was created in the 1970s under President Jimmy Carter, Federal Emergency Management Agency (‘FEMA’) has largely served as a federal backstop funding for states and local governments hit by natural disasters. However, FEMA has been forced to deny relief to more than a dozen disasters last year. Growing federal deficit and climate risks pose a challenge to federal disaster relief aid. FEMA’s Disaster Relief Fund faces a more than $6 billion deficit without supplemental appropriations. So far this year, the US has been hit by 15 weather and climate disasters each costing at least $1 billion. FEMA is working with the administration and Congress to ensure sufficient funding is available. Lawmakers are also urging U.S. states to take on a larger share of disaster relief funding.

Compare 30-Year taxable U.S. Treasury yield 4.42% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.72% “AA” 4.00%; “A” 4.20%. 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.