Municipal Bond News 9/25/23

Investor Attention On Higher Muni Yields…MTA Earns Positive Outlook…Bellwether Yields Rise…‘Higher For Longer’ Fed Rate Likely…Puerto Rico Tax Revenue Outperforms… Chicago Budget Gap Grows…U.S. States’ Pension Liabilities…

Investor Attention On Higher Muni Yields…Inviting the attention of tax- free income investors, current muni yields are the highest in sixteen years. Last week, tax-free yields surged 20 basis points, echoing a similar uptick in comparable United States Treasury bond yields. High tax bracket investors could lock in close to 7% taxable equivalent yield at current long-term yields. That’s much higher than the current 4.6% yield for similar-dated U.S. Treasury bonds. Higher yields could provide a compelling entry point for investors that have been waiting on the sidelines. Long term muni bonds are witnessing higher demand. An index of muni bond demand, cash inflows to long term muni funds have turned positive this year, while investors pulled out from short term securities. “We still believe that stronger performance in November-December for the asset class is a likely possibility, and market participants should be positioned accordingly,” Barclays strategists noted, “It is hard to pick an absolute bottom, but for investors willing to take a longer- term view, current yields and valuations versus Treasuries have already started to look attractive and might get even more appetizing.” No one can predict a peak yield. Amid volatility, a sound long-term investment strategy is to add to tax-free bond portfolios when tax-free yields are attractive.

MTA Earns Positive Outlook…Moody’s has raised the outlook for New York MTA from stable to positive. Boosted state tax support that will offset the post-COVID ridership losses and structurally balance projected budget gaps drove the favorable outlook. MTA’s finances improved significantly after NYS increased state taxes, such as the payroll mobility tax, increased state aid taken from its general fund, along with seeing New York City funding a greater share of para-transit expenses, and in the future casino tax revenue. MTA provides “an essential service to a vast and economically robust service area and strong political and financial support from New York State (Aa1/stable), New York City (Aa2/stable) and the government of the United States of America (Aaa/stable), which have been instrumental in supporting the credit through the coronavirus pandemic and recovery, per Moody’s. MTA CFO said “We think that it really underscores what we’ve been saying that the package that Gov. Kathy Hochul put forward and was approved by the legislature has, on a recurring basis, solved the fiscal cliff that we and other transit agencies across the country faced due to the lower ridership post-COVID.” MTA CEO echoed, “As I said back in July, Gov. Hochul and the state Legislature delivered for riders with this year’s budget, securing the MTA’s current and future financial stability,” Governor Hochul said “The MTA is a critical resource for millions of New Yorkers, and that’s why I fought so hard to save them from the looming fiscal cliff,” adding “The budget investments we made this year will make transit better for commuters. throughout the region, and I’m pleased to see Moody’s recognizing these investments through the improved rating outlook.”

Bellwether Yields Rise…Treasury yields touched a 16-year high last week. The benchmark 10- year Treasury note climbed up to 4.50 per cent. Longer-dated US Treasuries also sold off, with the yield on the 30-year bond rising 20 basis points to 4.60 per cent. The surge after the Federal Reserve penciled in a slower pace of rate cuts in 2024 and 2025, while holding its estimate of 2023 peak policy rate steady.

‘Higher For Longer’ Fed Rate Likely…As expected, the Fed did not hike policy rates at last week’s meeting. Unchanged from earlier estimates, the Fed envisions one more quarter-point rate rise this year. However, the Fed’s latest projection shows year-end 2024 and 2025 policy rates to be 50 basis points higher than its June estimate. Central bankers envision a peak fed-funds target rate of 5.6% this year, dropping to 5.1% in 2024 and 3.9% in 2025. Most central bankers suggest only two rate cuts in 2024. The U.S. economy is expected to grow at a 2.1% annual pace, higher than earlier expectations. Central bankers’ suggesting fewer rate cuts in 2024 and 2025 reinforces the Fed’s intent to keep policy rates higher for longer. Fed Chair Powell noted, “These are estimates made a year in advance. They’re highly uncertain.”

Puerto Rico Tax Revenue Outperforms…The Island’s Fiscal 23 general fund revenues outperformed board projections by 12.8% and are 1.6% below prior year. The biggest haul came from corporate taxes, income tax and sales use tax. Puerto Rico Treasury Secretary noted, “As we anticipated, we ended the fiscal year with a balanced budget where income exceeds disbursements, complying with all current obligations and the payment of the government’s debt, which affirms adequate management of public finances.” The Oversight Board said, “The Oversight Board succeeded in stabilizing a bankrupt government, ending decades of overpromising and overspending. Puerto Rico’s severe fiscal crisis turned into a durable recovery. The Oversight Board continues to ensure that the root causes of Puerto Rico’s past distress are fully addressed and rectified.” Stronger Island finances bode well for payouts on contingent value securities tied to the Island’s economic performance.

Chicago Budget Gap Grows…The third-largest U.S. city will need to close a $538 million budget gap in Fiscal 2024, which begins on January 1. The city expects to close Fiscal 2023, with revenues exceeding expenses by $60 billion. The budget gap is driven by rising payroll, pension, and contractual costs, and the cost to care for new migrants. Former Mayor Lightfoot had previously projected a roughly $85 million deficit for 2024. “The projected budget gap paints a realistic picture of our city’s financial condition, which will require careful consideration and strategic action,” Mayor Brandon Johnson stated. In previous years, Chicago has closed budget gaps scaling to $838 million in 2020 and $1.2 billion in 2021.

U.S. States’ Pension Liabilities…U.S. states pension liabilities exceeded funding by $7 trillion in 2022 and dropped $1.3 trillion from prior year. That’s about $21,000 in unfunded pension liabilities per person. Large states were the biggest contributors to the overall amount of unfunded liabilities, with California accounting for $1.4 trillion, Texas accounting for $437 billion and New York accounting for $368 billion, per American Legislative Exchange Council. Illinois had the second-highest unfunded liabilities at $468 billion.

Compare 30-Year taxable U.S. Treasury yield 4.59% to 30-Year tax-exempt Municipal Bond yield “AAA” 4.15%; “AA” 4.47%; %; “A” 4.73%. For investors in the 35% tax bracket, a 4.15% tax-exempt yield is equivalent to a 6.38% taxable yield. Top-rated long-term tax-free bonds yield 90% of comparable taxable U.S. Treasuries.