Municipal Bond News 8/26/24

Yield Advantage of Tax-Free Bonds…“Time Has Come” For Rate Cuts…Pace of Rate Cuts…New Muni Bonds Oversubscribed…New York Muni Bonds Stand Tall… Colleges Ramp Up Borrowing…Stadium’s Mixed Impact

Yield Advantage of Tax-Free Bonds…Prices of tax-free bonds, when compared to taxable bonds, are currently the lowest in 2024. A measure of relative value, the Muni-Treasury 30-year yield ratio, is currently at 89%, the highest this year. Top-rated long term muni bonds offer about 3.6% tax-free or 5.6% taxable equivalent yield. That’s 160 basis points of additional yield relative to comparable U.S. Treasury bonds. Current muni bond yields have dropped about 40 basis points since the start of the year. A surge in state and local government borrowing has led returns on muni bonds to underperform U.S. Treasuries. Bellwether yields tend to drift lower during the Federal Reserve’s rate cutting cycle, slated to begin in a few weeks. Muni bonds’ yield advantage is favorable for long term investors seeking tax-free income.

“Time Has Come” For Rate Cuts…The Fed is turning a corner in its rate cut policy. Fed Chair Powell clearly signaled that the Fed is ready to cut rates in September. For over a year, the Fed has held policy rates at 5.3%, the highest level in over two decades. “The upside risks to inflation have diminished,” Fed Chair Powell said last week “And the downside risks to employment have increased.” Fed officials want to protect the job market from weakening further and to keep the economy on a path for a soft landing. Powell noted “The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook and the balance of risks.”

Pace of Rate Cuts… The big question now is how far and how fast interest rates stand to decrease. Interest-rate futures markets are betting on front-loaded rate cuts. One percentage point of cuts in 2024, and at least another point of cuts by the end of next year carry the greatest odds. Several Federal Reserve officials view that there was a plausible case for cutting interest rates at the Fed’s July 30-31 meeting and recent economic data suggest front-loaded rate cuts. The ‘vast majority’ of Fed officials were in favor of a September rate cut. Once rate cuts start, “Don’t just start and stop,” Philadelphia Fed President Patrick Harker added “Just start the process and keep it moving” in a “methodical’ way. The Fed is likely to update its rate cut projections in September. Bellwether bond yields fell as investors priced in the possibility of steeper Fed rate cuts in the future.

New Muni Bonds Oversubscribed…Investors logged over three times worth of orders for $1.5 billion New York City general obligation bonds sold last week. High-grade New York City general obligation bonds yielded 3.85% for 5.25% tax-free coupon, 2050 maturity. Earlier this month, Chicago sold general obligation bonds rated S&P ‘BBB+’ Fitch ‘A-’ that fetch a yield of 4.17% for 5.25% tax-free coupon bonds maturing in 20 years. Strong investor demand for the tax-exempt bonds led to lower than anticipated yields. Last week, over $11 billion of new muni bonds were sold, among the highest weekly volume in the primary market this year.

New York Muni Bonds Stand Tall…Robust bond issuance, oversubscribed new bond sales and outperforming tax collections tell the story of New York’s muni bond market. New York governments have issued nine of the ten largest muni bond transactions in the north-east. Five transactions were from New York City and four from New York State. Dormitory Authority of State of New York secured the top spot with its $2.88 billion bond sale in March. JFK Airport’s $2.5 billion bonds issued in June is the second largest muni bond sale in the north-east. New York issuers offered $28 billion of bonds in the first half of the year. That’s up 55% from last year, when the state’s issuers sold $18.08 billion, and even above the $26.9 billion from the first half of New York’s historic 2022. Recent tax collections of both New York State and New York City have outperformed estimates. Most New York muni bond issues have been oversubscribed.

Colleges Ramp Up Borrowing…Muni bond sales by colleges have doubled from a year ago. The higher education sector requires between $750 million to $950 billion of capital upgrades over the next decade. Growing competition to lure high school seniors from a shrinking pool has made it crucial for colleges to upgrade campuses. Enrollment pressures have led many smaller schools to close. Colleges face mounting financial pressures. Stronger universities with large endowments are thriving as the sector contends with rising costs. Moody’s states “We expect the gap in capital spending rates between the sector’s strongest and weakest performers to widen further as credit strength continues to diverge.” US colleges and universities have about $246 billion of muni bonds outstanding.

Stadium’s Mixed Impact…State and local government subsidies to develop stadiums are at historically high levels. From 2020 to 2024, six new stadiums were completed in the four major professional sports leagues. Three of these received subsidies from states and local governments, and the other three were fully privately funded. Many new stadiums are part of mixed commercial and residential plans, and often designed to suit a wider range of events. Cities tout the economic benefits of stadiums. However, history suggests that the net economic impact is typically less than expected. Notably, long-term non-relocation agreements are an important aspect of government-subsidized stadium projects because they tie a team to a stadium until bonds are repaid. Moody’s views large stadiums as credit neutral for cities.

Compare 30-Year taxable U.S. Treasury yield 4.09% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.64% “AA” 3.98%; “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 89% of comparable taxable U.S. Treasuries.