Week of 03/22/2021

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Biden Set On Higher Taxes… Fed Stays Put On Near Zero Rates… America Rescue Plan A Transformative Opportunity For Puerto Rico… Illinois Yield Penalty Hits Seven-Year Low… ‘Golden Decade’ Ahead For Muni Bonds…

Biden Set On Higher Taxes…The first major tax hike since 1993 is on its way, President Biden shared with Good Morning America last week. A $1 trillion tax increase could be part of Biden’s agenda. Tax hikes could pay for part of Biden’s upcoming infrastructure plan which could cost anywhere between $2 trillion and $4 trillion. White House advisers are preparing for a package of measures that could include an increase in the individual rate for high earners. Some tax increases, such as rolling back tax cuts from the Republicans’ 2017 bill and increasing the rate on capital gains, have already been outlined in Biden’s campaign proposal. “We need to make sure that we connect the dots between the needs of the American people, making sure that we have fiscal sustainability and that we have a tax system that is fair and just, but that makes sure that we have the revenue that we need to do the things the government needs to do,” stated a member of the White House Council of Economic Advisers. Biden and the Democrat-controlled Congress are intent on a higher tax regime; the America Rescue Plan blocks states from using federal emergency funds to cut taxes through 2024. Biden acknowledged that Republican lawmakers’ votes are unlikely for any type of tax hike, but is confident that Democratic votes will advance tax reform. While federal debt will pay for the $1.9 trillion America Rescue Plan enacted earlier this month, tax hikes will pay for a portion of Biden’s upcoming federal spending plan for infrastructure per Treasury Secretary Janet Yellen.

Fed Stays Put On Near Zero Rates…No one was surprised that central bankers voted unanimously to keep overnight interest rates near zero and continue purchasing at least $120 billion of Treasury bonds and mortgage-backed securities monthly. Expecting recovery to gain steam, most fed officials expect to maintain ultralow interest rates through 2023. After a decade of inflation largely running below 2%, the Fed now seeks “inflation moderately above 2% for some time” to compensate for the past shortfall before it will consider raising rates. The Fed expects that a bump in inflation this year will be short-lived. Powell told lawmakers that the economy still has a long way to go before there’s any risk of overheating and any transitory inflation wouldn’t meet the Fed’s bar for raising rates. “The economy is a long way from our employment and inflation goals and it is likely to take some time for substantial further progress to be achieved,” Mr. Powell added, “We will continue to provide the economy the support that it needs for as long as it takes.”

America Rescue Plan A Tranformative Opportunity For Puerto Rico…Just America Rescue Plan A Tranformative Opportunity For Puerto Rico…Just Island will receive up to $10 billion in federal aid from the America Rescue Plan. Last Spring, CARES Act provided $13 billion federal aid. These funds are clearly positive for the territory’s near-term finances, Moody’s said. Senate Majority Leader Chuck Schumer (D) described the legislation as “the largest most complete package of aid to Puerto Rico that has come down the pike in a very, very long time.” Federal aid includes $4.2 billion direct aid to the central government, cities and counties, $3 billion for K through 12 schools, $1.2 billion for disaster relief, $747 million for higher education and millions of federal dollars for higher education, childcare, rental, mortgage, homeless assistance and the Island’s 10 airports. Stimulus checks to individuals and expanded child tax credits will inject roughly $275 million to the Island economy per an economic think-tank on the Island. Rep. Nydia Velazquez, D-N.Y. called the America Rescue Plan, “a transformative opportunity for the Island.”

Illinois Bonds Oversubscribed, Yield Penalty Hits Seven-Year Low….Long term bonds issued by the State of Illinois were oversubscribed by 18 times. Sixteen billion worth of orders came for Illinois’ $1.25 billion newly issued Illinois general obligation bonds. “The State received such strong demand and investor confidence that the bond sale was accelerated. Illinois received very impressive results, including more than 700 orders from more than 130 different investors, including respected names that have not invested in the State for a decade. This led to a contraction of credit spreads to 115 basis points over the benchmark in the longest maturity, the lowest in several years. Investors recognize the State is emerging from a period of unprecedented turbulence due to a global pandemic and the bond market recognizes the fundamental security of the State’s bonds. The State appreciates the heavy subscription from long time holders of its bonds and welcomes the new investors that Illinois is seeing,” Illinois’ capital markets director stated. Illinois’ yield penalty has eased since a unified Democrat-controlled state government took over in 2019. Political gridlock caused Illinois’ yield penalty to soar during the tenure of former Governor Bruce Rauner ( R). Headlines on dire COVID-19 forecasts, which never came true, caused the extra yield investors seek for the lowest rated U.S. state bonds to spike to 400 basis points in May 2020. Last week, S&P upgraded its outlook on Illinois general obligation bonds to stable from negative driven by significant federal support, administrative actions and improving economic conditions. Moody’s echoed, “Federal aid is clearly providing a substantial buffer to help absorb the pandemic’s fiscal effects, but the long term pension funding challenges will remain in place.” Illinois is an outlier among U.S. states both for fiscal challenges from significant pension underfunding and for its limited capacity to modify the benefit packages that drive these expenses. The lowest rated U.S. state allocates about 30% of its budget to retirement benefits and debt service, a “fixed cost” ratio more than three times the median for states. The $7.5 billion federal aid “could provide an immediate boost to the state’s fiscal resilience,” per Fitch Rating. 5% coupon bonds maturing in 25 years came with a 2.75% yield to call or 115 basis points more than top rated muni benchmarks. Substantial federal aid and a conservative budget plan have caused Illinois’ yield penalty to drop to a seven-year low.

‘Golden Decade’ Ahead For Muni Bonds…President Joe Biden’s recently enacted stimulus plan will kick start a “new golden decade of strong growth and strengthening credit quality” that’s reminiscent of the 1990s, Bank of America analysts said. Bank of America is the top underwriter for muni bonds. “The upcoming infrastructure bill will put the muni market at the center and overall muni credit should benefit from it and remain on a path of continuous improvement over this next decade.” The analysts added that “Higher marginal tax rates will make tax-exempt munis more appealing, thereby possibly attracting more investment capital to the decade of infrastructure construction to be undertaken.” Nationwide, states and local governments needed only $61 billion in additional aid to cover shortfalls through 2022 caused by the pandemic, after taking into account federal aid received so far per Moody’s Analytics, but received six times as much in direct federal aid, together with billions of additional federal aid for schools, transit, airlines and other municipal bond sectors.

Compare 30-Year taxable U.S. Treasury yield 2.47% to 30-Year tax-exempt muni bond yield “AAA” 1.87%; “AA” 2.02%; “A” 2.28%; “BBB” 3.26%. For investors in the 35% tax-bracket, a 3.25% tax-exempt yield is equivalent to a 5% taxable yield. Top rated tax-free bonds yield 76% of comparable taxable U.S. Treasuries.

Information obtained from sources deemed reliable; GMS does not purport Review/Preview contains all available information.