Week of 07/12/2021

Bond Yields Pull Lower… Junk Munis’ Record Rally… Rating Boost For Muni Bonds…Illinois’ Second Rating Upgrade… Renewed State Oversight Credit Positive For Atlantic City…Puerto Rico’s 2021 Title III Exit…Federal Reserve Nominations?…

Bond Yields Pull Lower… Could an economic slowdown be imminent if U.S. economic growth peaks in the second quarter of 2021? After all, future economic growth hinges on private spending rather than public spending. Investors reckon that Congress and the Federal Reserve might not provide quite as much stimulus as earlier anticipated. U.S. service sector activity declined in June from the previous month per ISM data and the Delta variant is feared. Central bankers don’t believe the threshold for tapering its monthly asset purchases has been met and the acceleration in inflation was seen as transitory, latest Fed meeting minutes reveal. U.S. GDP growth estimates are expected to trail down to2.3% in 2023from 5% in 2022 and 6.6% in 2021 Moody’s estimates. Without another fiscal package, growth could dip to a 1.5% to 2%annual pace in the second half of next year, stemming the fall in unemployment and possibly even pushing it higher, a Moody’s analyst shared. Yield on the bellwether 10-year U.S. Treasury fell to 1.25% last week, the lowest since February. Bench mark muni yields should end around where they started the year, with10-year tax-free bonds yieldendingtoward0.71%per the largest underwriter of municipal bonds, Bank of America. “Two weeks ago, Treasury rates plunged, but only briefly,” Bank of America strategists added “Now, the rally appears to have more staying power.” The mix of factors suggest that yields in the $4 trillion municipal bond market, already historically low, could drop even more.

Junk Munis’ Record Rally… Speculative grade or non-rated muni bonds are poised to make history in 2021. Investor confidence has grown leaps and bounds and credit spreads are near pre-COVID-19 levels. With about 70% of Americans vaccinated, credit spreads, or the yield gap between top grade and lower rated muni bonds, have narrowed. “Baa” rated muni bonds offer 63 basis points more yield than top rated tax-free benchmarks, down from about 100 basis points six months ago. Hard to find, lower rated muni bonds have been the most sought after this year. Borrowers with below investment grade credit ratings have found strong reception from investors. A “BB+” rated Florida retirement community’s new muni bonds issued in June met “exceptional demand from investors,” and fetched average yield of 3.02%, close to lowest yields in history for similar rated Florida senior living tax-free bonds. American Airlines’ “B” rated $150 billion muni bonds issued at par in June traded roughly around 106 cents on the dollar last week. The six biggest weekly inflows into high yield bonds on record have occurred in 2021, with the highest weekly inflows, $1.27 billion, on April 14. High yield state and local debt has returned nearly 7% so far this year, more than 5 percentage points more than top grade muni bond benchmarks, the biggest gap in annual returns since 2012.

Rating Boost For Muni Bonds… S&P has upgraded its ratings on nearly $38 billion muni bonds in 2021, a reversal from $79 billion bonds downgraded last year. Rating agencies’ outlook raises echo the same trend. Fitch has issued 145 favorable outlook changes this year, nearly six times more than a year ago. Despite widespread shutdowns, there were no COVID-19 related defaults on Moody’s rated bonds last year. In 2020, the one-year rating drift was a minuscule minus 0.4 notches per 100 credits for municipals compared with minus 22 notches per 100 credits for global corporates per Moody’s. While corporate bond ratings experienced more frequent rating downgrades, municipal bond ratings were resilient amid COVID-19 related pressures. An S&P analyst noted “We expect improved credit trends across public finance for the remainder of 2021.”

Illinois’ Second Rating Upgrade… Rewarding Illinois with a second upgrade in a week, S&P lifted its rating on Illinois general obligation bonds to “BBB” from “BBB-”. “The upgrade reflects our view of improved liquidity, demonstrated operational controls during the pandemic, and an improving economic condition,” a S&P analyst added that the stable outlook reflects the expected strength of the liquidity position and continued economic recovery. Without pension reforms, Illinois remains far from a high grade rating that is common for state bonds. Upon the upgrade, Illinois State Comptroller stated “my priority continues to be managing the state’s bill backlog and providing evidence to the credit rating agencies that Illinois is an excellent investment and is on a path to financial stability and certainty.”

Renewed State Oversight Credit Positive For Atlantic City… Governor Phil Murphy signed into law an four-year extension of state oversight of Atlantic City. State oversight, which began in 2016, is credit positive for the seaside city which seeks to diversify its economy beyond casinos. State oversight continues to evolve, with the state conducting talks with casinos and helping with labor relations in an advisory role. Although casinos shut down last year, meaningful revenue from online gambling was a charm. Improved governance during state oversight has earned high marks from ratings agencies, which upgraded Atlantic City bonds last year.

Puerto Rico’s 2021 Title III Exit… U.S. District Court Judge Swain has set confirmation hearings to settle central government debt restructuring from Nov 8 to Nov 23. If approved, Puerto Rico could exchange $18.8 billion of legacy general obligation and Commonwealth guaranteed debt for new bonds, cash and a contingent value instrument that would pay off if sales tax collections exceed targets. For the first time ever, the Title III court will consider retail bondholder representation in the Island’s central government debt restructuring. Cash balance in Puerto Rico’s government bank accounts jumped to $24.28 billion as of May 31, a 12.2% hike from a month ago. Much awaited exit from bankruptcy has implications for the Island’s bonds amongst the most actively traded muni bonds. Stepping stones for Puerto Rico’s restructured COFINA bonds to eventually seek an investment grade rating could come from the Island’s bankruptcy exit. Long term 5% COFINA bonds are trading around 115 cents, up from 97 cents when issued in February 2019, evidence that Puerto Rico’s COFINA bonds are outperforming triple tax exempt investments.

Federal Reserve Nominations?… Fed Chair Jerome Powell, Vice Chairs Richard Clarida and Randal Quarles are nearing the end of their terms at the Federal Reserve. The White House isn’t looking at the chairmanship in isolation, but rather what mix of governors to appoint so as to reshape policy toward the administration’s agenda. A decades long tradition of maintaining continuity in Federal Reserve leadership, once broken by President Trump, suggests Powell could be asked to stay. Treasury Secretary Janet Yellen has no complaints about how her former co-worker, Powell, steered monetary policy during the pandemic. Top White House officials are expected to weigh on top central bank nominations.

Compare 30-Year taxable U.S. Treasury yield 1.96% to 30-Year tax-exempt muni bond yield “AAA” 1.40%; “AA” 1.53%; “A” 1.70%; “BBB” 2.14%. For investors in the 35% tax-bracket, a 2.15% tax-exempt yield is equivalent to a 3.3% taxable yield.  Top rated tax-free bonds yield 71% of comparable taxable U.S. Treasuries.

If you have any questions or desire updated information contact your GMS Account Executive.