Week of 3/28/2022

Municipal Bonds Sell-Off…Powell Comments Spur Wall Street Rate Bets…Puerto Rico Bankruptcy Exit Credit Positive… Assured Rating Upgrade Boosts Bond Insurance Demand… Chicago Selects Casino Finalists…

Municipal Bonds Sell-Off … Municipal bonds had their worst day since the COVID-19 related selloff of April 2020. Top-rated municipal bond yields soared by about 20 to 25 basis points, driven by a U.S. Treasuries sell-off. Bellwether U.S. Treasury yields shot up, with the 10-year U.S. Treasury hitting 2.5%, the highest since May 2019, amid predictions of faster rate hikes by the Federal Reserve. Outflows from municipal bond funds for eleven straight weeks has accelerated the selling pressure in the municipal bond market. Top rated municipal bonds have lost over 6% this year per Barclays indices. Last week, New York City’s high grade $953 million bonds fetched 2.61% tax-free, double the yield offered in a previous bond sale in August 2021. While some strategists ‘don’t necessarily expect a quick snap back’ others term the municipal bond market as ‘oversold.’

Powell Comments Spur Wall Street Rate Bets… “If we conclude that it is appropriate to move more aggressively by raising the federal funds rate by more than 25 basis points at a meeting or meetings, we will do so,” Fed Chair Powell said in a speech titled “Restoring Price Stability” last week. Powell’s comments struck a tone suggesting more aggressive rate hikes compared to his stance at the March 16, 2022 Federal Open Markets Committee meeting when he shared medians of central bankers’ forecasts. New York Federal Reserve President John Williams echoed Friday said that if a supersized 0.5 percentage point rate increase was warranted to combat intense inflation, the central bank should move forward. For quite some time, St. Louis Fed President James Bullard has spoken up for a 50 basis point rate hike. Powell’s comments echoed through Wall Street, as Goldman Sachs and Citigroup raised their forecasts to a faster pace of Federal funds rate hikes than earlier anticipated. Citigroup economists now expect half-point moves at the next four meetings followed by two quarter-point hikes in October and December. By comparison, Goldman Sachs expects the Fed to raise rates by a half point at the next two meetings in May and June, followed by quarter point hikes at the four remaining meetings in 2022, and three hikes in 2023. Citigroup sees a 2.75% federal funds rate by the end of 2022, and up to 3.75% at the end of 2023. Recent Wall Street projections are beyond the 2.8% level reflected in the Federal Reserve’s latest median projections. Futures markets on Friday priced in a 2.5%-2.75% fed funds rate by year end and a mid-2023 peak of 3% to 3.25%. Fed Chair Powell said policy makers are now no longer assuming significant relief on supply-chain issues and will be looking for “actual progress” on inflation to guide interest rate decisions.

Puerto Rico Bankruptcy Exit Credit Positive… “Creditors and the market in general will understand that Puerto Rico is a new credit now,” Puerto Rico fiscal agency executive director added “We now have a cleaner, clearer, and more certain debt profile for creditors and the market.” On March 15, 2022, Puerto Rico central government debt restructuring became effective, ending the Island’s historic bankruptcy. The Island cut its legacy debt from $33 billion to $7 billion, and holders of legacy central government bonds received a cash payout, new general obligation bonds and contingent value securities. The Island’s Treasury cash pile is at $4.8 billion, which is after over $10 billion in cash payouts required by the debt plan. The Island has resumed paying debt service after a gap of nearly six years. Guardrails to prevent the Island from repeating past mistakes that led to unsustainable debt include more stringent debt management policies. The end of bankruptcy could usher economic growth as the Island’s annual debt service will be a ‘stable, affordable, and predictable $1.15 billion each year’ down from $3.9 billion before the debt exchange. “What we saw in Detroit was that after getting out of bankruptcy, it really did help fuel an economic boost and economic growth. So, we are very hopeful that it does that here,” Oversight board executive director Natalie Jaresko said. The federal oversight board will continue to steer Puerto Rico’s finances. The Island’s exit from bankruptcy ends the uncertainty of the Title III judicial process, and is expected to boost investor demand for the Island’s triple tax-exempt bonds. “These settlements are a huge step forward for Puerto Rico,” Assured Guaranty CEO added “we hope that the current settlements will bring forward renewed respect for consensual agreements and the rule of law, and with it, access to the capital markets for Puerto Rico.” New Puerto Rico general obligations bonds began trading with yields ranging from 3.6% to over 4%.

Assured Rating Upgrade Boosts Bond Insurance Demand… Moody’s upgraded the rating of Assured Guaranty Municipal Corp. to ‘A1’ from ‘A2’. The upgrade reflects Assured’s “improved credit profiles following the resolution of the group’s exposure to the general obligation bonds issued by the Commonwealth of Puerto Rico and limited expected volatility among its remaining Puerto Rico exposures.” Moody’s noted. The demand for financial guaranty insurance is trending favorably. Assured Guaranty leadership stated, “The upgrade reflects that Moody’s has recognized our strong capital profile and the expanding demand for bond insurance.” During Puerto Rico’s bankruptcy and throughout the pandemic, Assured insured bondholders received debt service on time and in full, bringing peace of mind. The upgrade has “recognized the expanding demand for bond insurance and Assured Guaranty Municipal’s strong capital profile and resilient business model, as well as that we are at a turning point in terms of our growth after a long period of reducing legacy exposures,” Assured CEO added “With the cloud of our Puerto Rico exposure largely lifted and the capital markets experiencing increased volatility and rising interest rates, AGM is poised to continue growing its insured portfolio to sustain and increase its store of unearned premiums, its future earnings power and its financial strength.” Favorable for both municipal bond issuers and insured bondholders, the upgrade boosts the demand for Assured’s financial guaranty.

Chicago Selects Casino Finalists… The sweepstakes for a Chicago casino is down to three contenders: Bally’s, Hard Rock and Rivers 78. Bally’s $1.8 billion capital plan could bring up to $191 million annually to city coffers, relative to Hard Rock’s $1.7 billion build out worth $185 recurring annual city income. Roughly the same level of recurring revenue would go to the State of Illinois. The selection process is more than just numbers. Each blue print is set in a different city location. The Mayor is seeking community input before the city will negotiate with each of the finalists and then pick one to present for City Council approval by “early summer”. The winner would have to be vetted by the Illinois Gaming Board, which issues casino licenses. It could be over a year or so before ground is broken for the casino-resort. The Chicago casino would be the largest in the state, would also carry with it the highest casino tax rate in the state at about 40% of adjusted gross revenue. Incremental cash flow from casino taxes will fund city police and fire pensions.

Compare 30-Year taxable U.S. Treasury yield 2.58% to 30-Year tax-exempt muni bond yield “AAA” 2.56%; “AA” 3.05%; “A” 3.31%; “BBB” 3.83%. For investors in the 35% tax-bracket, a 3.83% tax-exempt yield is equivalent to a 5.9% taxable yield. Top rated tax-free bonds yield 99% of comparable taxable U.S. Treasuries.