Municipal Bond News 7/24/23

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Long-Term High-Yield Muni Bonds Biggest Winners… Muni Bond Demand Grows…MTA’s Balanced Budget Forecast…Cost Relief for Hospitals Amid Nurse Shortage…New York State Warns Budget Gaps…Fed Closer to Final Rate Hike…

Long-Term High-Yield (HY) Muni Bonds Biggest Winners…The riskiest state and local government long-term bonds have returned 6.4% this year, double the overall municipal bond market’s 3.2% return. Broad expectations for a soft landing favor the credit conditions for lower-rated borrowers. Stability in interest rates favors longer-dated municipal bonds. Credit spreads on the HY muni bonds could narrow as much as 70 basis points this year, Bank of America strategists said last week, adding “Of course the risk is whether the economy eventually does avoid recession, with the current consensus that it can, at least for the remainder of 2023.” Continued solid jobs gains, unemployment rate near a historic low at 3.6%, and a greater-than- expected drop in consumer prices have led economists to gradually lower recession expectations. Odds of a recession this year are at 58% per a recent Bloomberg economists survey, down from 67% in April.

Muni Bond Demand Grows…Wealthy investors are taking advantage of higher tax-free income from muni bond investments. The benchmark 10-year muni now yields about 2.45%, up from around 1% at the end of 2021. Higher tax-free yields are a silver lining for buyers of state and local government bonds. Aggressive fed-funds rate hikes led bond funds to sell muni bonds to meet investor redemptions. Last year, state and local government bond returns plunged 8.5%. This year, outflows from bond funds have declined, with cash inflows in some weeks. Last week, $1 billion of new municipal bonds were purchased by mutual funds as demand for tax-free bonds soared. A shift in bond fund demand is constructive for muni bond returns. State and local debt performance has been “solid”, Barclays strategists added that municipal bond valuations have room to go higher after the Federal Reserve’s July meeting. Investors are taking advantage of higher tax-free yields, while they last.

MTA’s Balanced Budget Forecast…The nation’s largest mass transit now projects five straight years of balanced budgets, a turnaround from gaping deficits forecast earlier. Hard-hit by the pandemic, MTA will benefit from additional tax revenue, operating savings, and farebox increases. A new payroll tax revenue will bring in $5.1 billion through 2027, and another $1.2 billion will come from fare box and toll increases. Annual operating savings of $500 million will start in 2025. MTA’s congestion pricing plan faces opposition from New Jersey and Staten Island. MTA estimates ridership will increase to about 80% of pre-pandemic levels by 2027, up from about 70% at present. Massive federal aid helped MTA tide over a drastic ridership decline during the pandemic. “This is a huge success story,” MTA’s CFO said last week as MTA’s budget is balanced for five consecutive years with recurring revenue and operating savings, adding “Today’s plan shows MTA’s transition from an uncertain financial future to a balanced plan for many years to come.” However, a watchdog group, Citizens Budget Commission warns that manageable shortfalls, in the range of $100 million to $400 million through 2028 could emerge next year. MTA responded, “It seems reckless to speculate about unknown numbers years after the end of the financial plan, assuming that expenses will rise faster than revenues without actual data.” While the MTA has yet to report its long-term budget projections, the agency expects its budget to be balanced from 2023 through 2027.

Cost Relief for Hospitals Amid Nurse Shortage…Labor stresses have abated. Hospitals are getting some relief from easier staffing. That means they are no longer reliant on pricey contract labor. However, a national shortage of nurses is expected at least until 2030, a fallout of aging demographics. Talks with unions are often costly, given the challenging nursing strikes in California and New York. Hospitals’ operating margins have weakened. A third of Moody’s-rated hospitals generated weak operating cash flow margins below 3%, compared to 6% pre-COVID-19. Hospitals are finding new care models and strategies to cope. Some hospitals are collaborating with universities to invest in nursing education, to build a pipeline of future healthcare workers. Others are creating internal float pools to leverage skills across affiliated healthcare providers. A few are looking overseas to recruit nurses and using telemonitoring and artificial intelligence to cut costs.

New York State Warns Budget Gaps…New York State is facing a $36.4 billion budget gap through fiscal 2026. Weaker forecast economic growth and higher state spending are drivers. The state is projecting operating funds revenue will decline 10% from the current fiscal year through 2026 as expenditures are expected to grow about 18%. New York’s tax collections are sensitive to financial markets. Personal income tax collections are expected to fall for a second straight year in Fiscal 23. While the state has increased statutory rainy-day reserves to a record $6.3 billion, they are “insufficient to close budget gaps in their entirety and are not a substitute for prudent fiscal discipline,” NYS Comptroller urged lawmakers to curtail spending.

Fed Closer to Final Rate Hike…Wall Street expects the Fed to lift interest rates one more time this week, before ending the most aggressive rate hike cycle in over four decades. Last month, central bankers estimated two additional rate hikes in 2023. Recently, Fed Chair Powell said there could be ‘one or two more’ rate hikes this year. With price pressures waning last month, traders are betting that this week’s expected rate hike could be about the last of the Fed’s ongoing rate hike cycle. The Fed has signaled additional rate hikes following a pause in June that was intended to slow the pace of rate hikes. Economists estimate fed-funds rate will stay higher longer, with the earliest rate cuts sometime in 2024. After about sixteen months of rate hikes, policy rates are the highest since 2001.

Compare 30-Year taxable U.S. Treasury yield 3.88% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.50%; “AA” 3.87%; “A” 4.10%. 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 90% of comparable taxable U.S. Treasuries.