Week of 10/14/2019

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Ultra-Low Bond Yields Could Shrink More… Weak Inflation in September… Governor’s Plan For Boosting IL Pension Returns… Chicago Public Schools Talks with Teachers Advance… Supreme Court Upholds Puerto Rico Bondholder Lien… New York Bond Supply To Dominate Calendar…

Ultra-Low Bond Yields Could Shrink More…Despite today’s ultra-low yields, bonds may still pay off handsomely if recession strikes. A recession would probably lead the 10- year treasury bond to bottom out in the range of 0.5% to 1% and the 30-year to a range of 1% to 1.5% per Moody’s forecasts. Lower yields are predicated on a slower U.S. GDP growth. U.S. manufacturing is in recession, two-thirds of economic forecasters said in a WSJ survey, and overall growth in the second half of 2019 is expected to further slow. Economists lowered expectations for third quarter economic growth to 1.82% and 1.77% rate in the fourth quarter. U.S. real GDP growth is estimated to be 2.3%, 1.7%, and 1.8% in 2019, 2020, and 2021, respectively per S&P. 90% of global economy is decelerating in a sharp reversal from two years ago when 75% of the world economy was accelerating, IMF’s new chief opined. The aging of the U.S. workforce and population has reduced the underlying growth rates of wages and inflation calling for lower interest rates despite a historically low unemployment rate. A sign of sagging investor expectations for economic growth and inflation, the U.S. government’s sale of 30-year bonds last week drew a record low yield of 2.17%. Treasury bond yields are likely to set new multi-decade and possibly new record lows within the next five years. Recession simply defined is a contraction in GDP for two consecutive quarters, which is not in the forecast for the foreseeable future.

Weak Inflation in September…U.S. consumer prices were flat in September and producer prices fell to the lowest this year. Weaker-than-expected Consumer Price Index (CPI) reading for September follows an unexpected drop in prices that businesses receive for their goods and services. Adding further credence to expansionary monetary policy of low rates, the Fed will purchase shorter-dated Treasury bills from October through mid-2020. Federal Reserve bond purchases remind investors of economic stimulus offered by central banks to ward off recessionary forces although the Fed does not spell it as a stimulus. The move signals that the Federal Reserve is intent on achieving low rates. Fed Chair Powell reiterated last week, “we will act as appropriate to support continued growth, a strong job market, and inflation moving back to our symmetric 2 % objective.” Majority of traders expect that the Federal Reserve could cut rates by 25 basis points on October 30 which could be the third rate cut this year.

Governor’s Plan For Boosting Illinois Pension Returns…Governor Pritzker unveiled a bipartisan plan to consolidate 650 local police and fire pension funds into two statewide funds to bring higher investment returns. Investment returns for locally managed pension funds have lagged because small separately managed pension funds lack the investment scale and liquidity to maximize returns. By remaining separate, the pension funds forfeit $1 million daily of investment returns and bear higher overhead cost. Together, the public safety pension funds have enough assets to cover only 55% of liabilities. Uniting the funds could mean additional returns of $820 million to $2.5 billion over the next five years, and $3.6 billion to $12.7 billion over 20 years, bringing the funds closer to the target 90% funded ratio by 2040 per a bipartisan taskforce. Illinois’ non-public safety pensions outside Chicago, consolidated into the Illinois Municipal Retirement Fund, have benefited from a higher 7.6% investment return. To be clear, the bipartisan plan does not deal with $134 billion in unfunded liabilities in statewide retirement systems and Chicago’s nearly $30 billion in unfunded liabilities across four funds. A separate task force on the sale or asset transfers to shore up Illinois state pension funds is still exploring options. Per the Plan, each police or fire department would maintain a separate account within the consolidated fund, the money would be held in a pair of trusts separate from the state treasury and benefits could still be administered locally. Traditionally, unions have opposed consolidation. However, the bipartisan plan has the support of Illinois’ largest firefighters union and some police unions. The Plan also recommends partially rolling back certain pension payments to newer hires that could be offset by consolidation savings. Illinois House Speaker Michael Madigan will take the proposal under review. Feeling good about the plan prospects for veto session at the end of the month, Governor Pritzker is optimistic because a bipartisan task force ensured “we had all the voices heard from in the process.” Pension funding shortfalls have pressured Illinois local government ratings. Addressing unfunded pension liabilities for local governments and the surging property tax burdens they create are among the most critical fiscal challenges before the first-time Governor.

Chicago Public Schools Talks with Teachers Advance…A conciliatory tone between Chicago Public Schools and its teachers emerged over the weekend. Towards reaching an agreement this week on a contract, Chicago teachers agreed to soften demands on class room size and staffing. On Saturday, the union said they are open to a phased approach to cap class sizes and ramp up staffing. This gives the mayor a path to get an agreement if that is her desire. Mayor Lightfoot and Chicago Public Schools CEO jointly stated, “we’re pleased to see more progress at the negotiating table than at any time up to this point” adding “we remain committed to doubling down on our shared efforts, coming back to the table, and getting to an agreement.” Both sides are back at the bargaining table intent on working out a deal to avert a proposed strike.

Supreme Court Upholds Puerto Rico Bondholder Lien…On October 7, 2019, the U.S. Supreme Court upheld bondholders’ perfected lien on government pension contributions by allowing a favorable First Circuit ruling on liens to prevail. In January 2019, the First Circuit Court of Appeals ruled that the lien granted to Puerto Rico pension bondholders lien was perfected. The First Circuit overturned the Title III Court’s August 2018 ruling that bondholders did not have a perfected lien on government contributions to the pension system. The Supreme Court declined the Oversight Board’s petition opposing the First Circuit ruling. The government is currently putting nearly $2 billion in the annual budget to fund the retiree pensions. The ruling boosts recovery potential for $3.2 billion Employee Retirement System (ERS) bonds up to as much as 100 cents from 13 cents proposed by the Oversight Board in the current Plan of Adjustment. The Oversight Board contends that the Supreme Court action does not impact the Plan. Litigation on the validity and security of the ERS bonds is ongoing in the federal district court. Next week, hedge funds owning Puerto Rico General Obligation (GO) debt will argue in the Supreme Court that the Oversight Board’s appointment was unconstitutional potentially throwing into question the board’s actions dating back to mid-2016. The Supreme Court ruling presents an additional hurdle for the controversial Plan of Adjustment for Puerto Rico GO, PBA and ERS bonds and sets a precedent favoring bondholder liens.

New York Bond Supply To Dominate Calendar…This week, the New York State Thruway Authority (NYSTA) will sell its first big bond deal since getting a Moody’s Investors Service upgrade and replacing the Tappan Zee Bridge. The NYSTA is scheduled to hold a $2.65 billion transaction next week comprised of $950 million of federally taxable Series M general revenue bonds and $1.7 billion of general revenue Series 2019B junior indebtedness obligations; senior bonds are rated Moody’s ‘A1’ S&P ‘A’ and junior bonds rated Moody’s ‘A2’ S&P ‘A-’. With a mix of taxable and taxexempt bonds, the Empire State bonds are expected to draw broad investor interest from investors seeking tax shelter as well as foreigners, foundations and pension funds seeking high credit quality of U.S. municipal governments.

Compare 30-Year taxable U.S. Treasury yield 2.19% to 30-Year tax-exempt muni bond yield “AAA” 1.99%; “AA” 2.24%; “A” 2.43%; “BBB” 2.94%. For investors in the 35% tax-bracket, a 2.9% tax-exempt yield is equivalent to a 4.5% taxable yield. Top rated tax-free bonds yield 91% of comparable taxable U.S. Treasuries.