Municipal Bond News 8/19/24

Long Term Muni Bonds Favored…Muni Bond Upgrades Outpace Downgrades…Muni Bonds Steady Amid Volatility… Rate Cut Odds…New Jersey Earns Credit Outlook Boost… Puerto Rico CVI Bonds Rally…Hospital Sector Credit Variation…Harris Seeks Tax Hike on High Earners…

Long Term Muni Bonds Favored…Investors looking to outperform should specifically focus on long-dated bonds with a 4% coupon, Bank of America strategists recommended last week. The strategists noted that treasury yield moves “appear consistent” with a slowing economy and slowing inflation “bringing bond investing back in fashion.” Muni bonds have posted 1.2% index returns this year. Investors expect the muni bond rally to accelerate. Bondholders are coming off some difficult years. Bond prices, which move inversely to interest rates, languished as the Federal Reserve spent much of 2022 and 2023 raising rates. With the Fed poised to start its rate cutting cycle, bond investors are positioned much better today.

Muni Bond Upgrades Outpace Downgrades…Moody’s upgraded twice as many muni bonds as it downgraded in the second quarter. Credit upgrades have outpaced downgrades for fourteen straight months. Favorable outlook changes have also surged higher. Local governments and infrastructure accounted for the most upgrades. In contrast, healthcare and higher education had more downgrades than upgrades. Los Angeles schools was the largest issuer to be upgraded, while RWJ Barnabas Health, New Jersey was the largest to be downgraded by Moody’s in the second quarter. The credit quality of municipal bond issuers has been boosted by continued economic stability and stronger government finances.

Muni Bonds Steady Amid Volatility…Investors have been adjusting their portfolios in anticipation of the Fed’s rate cutting cycle, leading to increased demand for municipal bonds. Last week, despite turbulent market conditions, yields for state and local government bonds stayed consistent. Most sensitive to rate policy, the two-year U.S. Treasury bond yields fluctuated between 3.94% on Tuesday to 4.12% on Thursday. However, longer-dated U.S. Treasury bonds rallied, with yields about 7 basis points lower than a week ago. For seven straight weeks, investors have poured cash to muni bond funds. High yield and longer-dated muni bonds are most sought. Many primary market muni bond offerings have been oversubscribed. Long-term investors are taking advantage of opportunities to generate tax-free income from muni bonds, undeterred by day-to-day yield fluctuations.

Rate Cut Odds…Fears of a recession eased somewhat. Amid signs of a ‘soft landing’ for the U.S. economy, investors dialed back odds of super- sized rate cuts. Bond markets anticipate a quarter point rate cut in September, and less than 100 basis points of rate cuts this year. Retail sales surged 1% in July, the most in a year and a half and well above consensus estimates. Inflation fell to 2.9% in July. For the first time in three years, the headline consumer price index fell below 3%. With the Fed poised to begin its rate cutting cycle next month, all eyes are on the Federal Reserve’s annual Jackson Hole meeting this week.

New Jersey Earns Credit Outlook Boost…Moody’s raised its outlook to positive from stable and affirmed its ‘A1’ rating on New Jersey general obligation bonds. The Garden State’s strong economy outpaces its mid-Atlantic peers. “Prospects for strong economic and revenue performance that will allow the state to narrow its structural gap and retain substantial budgetary reserves while maintaining full actuarial pension contributions in fiscal 2026,” led to the outlook boost. Governor Murphy said, “This latest Moody’s outlook revision from stable to positive is evidence that our formula to strengthen New Jersey’s economic trajectory is working.” Last week’s favorable rating action comes after all three ratings agencies upgraded Moody’s last year.

Puerto Rico CVI Bonds Rally…The prices of Puerto Rico’s contingent value bond (‘CVI Bonds’) have shot up. CVI bonds were issued as part of the Island’s general obligation debt restructuring. CVI bondholders are entitled to receive payments if and when the Island’s 5.5% sales and use tax collections exceed the amount pledged to sales tax secured COFINA bonds. The commonwealth collected $1.8 billion of sales-tax revenue from its 5.5% levy in fiscal 2024. That’s $565 million above the baseline for fiscal 2024. By mid-September, Puerto Rico will calculate the amount of excess sales-tax revenue that CVI investors will receive. CVI bondholders received $388 million last year and $362 million in 2022. CVI Bonds correlate with the Island’s economy. A CVI bond maturing in 20 years is currently trading at 67 cents on the dollar, up from about 57 cents when these bonds were issued in 2022.

Hospital Sector Credit Differentiation…Post-pandemic financial recovery has varied across the hospital sector. Higher rated hospitals are leading the recovery, while speculative grade rated hospitals saw profitability decline in 2023. Hospital revenue growth has rebounded, supported by higher patient volumes and supplemental funding in several states. However, expenses grew 0.3% faster than revenues in 2023. Lack of scale and inability to leverage resources led smaller hospitals to post losses in 2023, and operating margins declined for a second straight year. For larger hospitals, operating margins improved moderately in 2023. The Hospital sector’s financial recovery will continue, though the time frame could be longer for smaller hospitals. The gap between larger and smaller hospitals’ financial performance has widened. A Municipal Bond Specialist’s expertise in credit selection is valuable.

Harris Seeks Tax Hike on High Earners…Democratic presidential nominee Kamala Harris wants to raise taxes on incomes exceeding $400,000. Expanded health insurance premium subsidies for Affordable Care Act health insurance plans, more affordable housing, first-time homeowner assistance and tax credits are part of the Harris agenda. Harris has not addressed stance on the 2017 Tax Cuts and Jobs Act yet. Meanwhile, Republican nominee, former President Donald Trump, supports extending the 2017 tax cuts, and wants to pay for them through tariffs on China. There are concerns that Trump’s tariff proposal and some of Harris’s spending plans could rekindle inflation. Both candidates are likely to face questions on the rising federal debt.

Compare 30-Year taxable U.S. Treasury yield 4.11% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.62% “AA” 3.94%; “A” 4.21%. 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 88% of comparable taxable U.S. Treasuries.