Municipal Bond News 9/23/24

How To Position Your Muni Bond Portfolio Ahead of The Election…Muni Bonds Are Hitting On All Notes…First Rate Cut Larger Than Expected…Wall Street At Odds With Fed…‘Mega Muni Bonds’ Boom…SALT on Election Agenda… MTA Seeks Capital Funding Fix…

How To Position Your Muni Bond Portfolio Ahead of The Election… “With the Federal Reserve rate-cutting cycle now underway and the November election just around the corner, now could be a good time to invest in municipal bonds. For one, they are a way to lock in yield as interest rates fall,” CNBC wrote last week. The too-close-to-call election is bringing a lot of uncertainty related to the expected expiration of tax cuts at the end of 2025. Absent any congressional action, the top federal income tax rate will revert higher to 39.6% from 37% now. Also on the table is the alternative minimum tax, or AMT, a tax individuals have to pay if their income exceeds certain thresholds. Under the Tax Cuts and Jobs Act, about 200,000 taxpayers were impacted by the AMT. However, this number could rise to 7.6 million if the legislation expires. If there is a divided government or a Democratic sweep of both the White House and Congress, there is potential for taxes to be meaningfully higher. This could make the tax exemption offered by municipal bonds even more valuable.

Muni Bonds Are Hitting On All Notes…One of the best entry points for investors seeking tax-free income comes in the wake of currently higher muni bond issuance. “Right now, municipal bonds offer an attractive opportunity, particularly for tax-sensitive investors. It’s worth remembering that bonds— whether taxable or not—act as a ballast, balancing the more volatile equities in a well-diversified portfolio,” Barron’s wrote last week. The muni yield curve, or the yield gap between shorter and longer tax-free bonds is much steeper than the Treasury yield curve, indicating that tax-free bonds offer a relative yield advantage. Although yields have declined since 2023, they still offer an attractive return, particularly on an after-tax basis. States and local governments are financially stronger today than they were before previous downturns, most notably at the start of the Covid-19 shutdowns in 2020 and the global financial crisis in 2008.

First Rate Cut Larger Than Expected…The Federal Reserve cut its benchmark policy rates by 50 basis points last week, signaling the start of a new cycle of lower policy rates. The Fed’s first rate cut since 2020 is a significantly larger reduction than the quarter-point cut projected by most officials in June. Eleven out of the 12 officials on the Fed’s monetary policy committee voted for the half-point cut. This marked the first time in more than two years that an interest rate decision was not unanimous. The Fed seeks to pre-empt any weakening of the US economy and labor market after more than a year of holding rates at their highest level since 2001. Powell said rates were not on a “preset” path, noting that if inflation proved sticky the Fed could “dial back policy restraint more slowly”, and is “prepared to respond” if the labor market weakened.

Wall Street At Odds With Fed…Wall Street is forecasting a quicker pace of rate cuts than Fed officials’ estimate. JP Morgan and Citigroup anticipate a 50-basis point rate cut in November if the labor market softens. Goldman Sachs, Morgan Stanley and Deutsche Bank expects a string of consecutive quarter point rate cuts from November through March or June 2025. Bank of America expects the Fed “will get pushed into deeper cuts” with another 75 basis points coming in the fourth quarter and 125 basis points next year. Wells Fargo expects the Fed could ultimately cut by as many as 350 basis points in a hard-landing scenario, or 150 basis points in a soft-landing scenario, in its first year of its cutting cycle. On the other hand, Fed officials project an additional half a percentage point of rate cuts this year, and 100 basis points of rate cuts in 2025.

Mega Muni Bonds’ Boom…One in five new bonds sold this year is a billion dollar plus offering. The pipeline of ‘mega muni bond’ offerings is growing. The volume of ‘billion-dollar plus’ muni bond sales is at a record high. This year, states and locals have sold 42 muni bond issues that exceeded $1 billion. Of the $325 billion new muni bonds sold this year, some $65 billions of those offerings are mega-deals, the most in at least a decade. Los Angeles Schools, State of Connecticut and Texas Water Development are all planning to sell billion dollars plus muni bond issues in the near future.

SALT on Election Agenda…Former President Trump, the Republican nominee, intends to reverse the $10,000 cap on the state and local tax deduction (SALT) enacted as part of his 2017 Tax Cuts and Job Act. It remains to be seen if Vice President Harris follows suit with a competing proposal to lift the SALT cap. Efforts to remove the cap in Congress since the 2017 tax overhaul have not been successful. Lawmakers in high tax states have vowed to ensure that the SALT cap is lifted. The cap on SALT tax deductions contributed to massive domestic migration. California, New Jersey, Illinois, Texas and Pennsylvania stand to benefit from a SALT cap repeal. Although Texas has no income tax, it has high property taxes, similar to other states with no income taxes. The expiration of the SALT deduction cap in 2026 or its earlier removal through legislation could have significant tax implications.

MTA Seeks Capital Funding Fix…The nation’s largest transit system is seeking to invest $65.4 billion to upgrade infrastructure over the next five years. Nearly half of the proposed budget doesn’t have a potential funding source. In addition, an indefinite pause on congestion pricing has left a $15 billion void in the current capital plan. The MTA has finished less than half of its $55 billion 2020-24 capital plan. The price tag for MTA’s upkeep for the next five years varies from as high as $115 million per the Citizens Budget Commission to upto $92 billion per the New York State comptroller. Available funding ranges from $30 billion to $71 billion over the five-year period. A state comptroller’s report suggests, that based upon expected federal, state, city and own -source funding, the MTA could potentially afford to issue $12 billion to $21 billion of new bonds.

Compare 30-Year taxable U.S. Treasury yield 4.11% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.54% “AA” 3.86%; “A” 4.03%. For investors in the 35% tax bracket, a 3.5% tax-exempt yield is equivalent to a 5.38% taxable yield. Top-rated long-term tax-free bonds yield 86% of comparable taxable U.S. Treasuries.