Week of 3/7/2022

Powell Signals 25 Basis Point March Rate Hike…New Jersey Credit Upgrade…Moody’s Upgrades Chicago Board of Education… Could California See A Rating Upgrade… Connecticut’s Surplus…Puerto Rico Revenue Outperforms…More ESG Municipal Bonds…

Powell Signals 25 Basis Point March Rate Hike… “I am inclined to propose and support a 25 basis-point rate hike,” Powell struck a cautious note on Capitol Hill last week adding “The bottom line is that we will proceed but we will proceed carefully as we learn more about the implications of the Ukraine war for the economy.” Russia’s role in the global energy and commodity markets will contribute to “upward pressure on inflation at least for a while.” Powell left the door open for more aggressive rate hikes to the extent high inflation is persistent. Last year, Fed officials attributed most of the rise in inflation to supply-chain bottlenecks, expected to be resolved with post-COVID-19 reopening. But the war on Ukraine has made Powell more pessimistic. “What the textbook says is the shock is going to come and it’s going to go and and you shouldn’t react to it,” Powell said. “Hindsight says we should have moved earlier and that that turned out to be wrong.” “We have substantial excess demand.” Unprecedented federal stimulus helped fuel a rapid recovery from the COVID-19 downturn, but also boosted pressure on supply chains snarled by pandemic-related obstacles. “It’s just taking so much longer for the supply side to heal than we thought,” he continued. “There really is no precedent for this.” The “near-term effects on the U.S. economy of the invasion of Ukraine, the ongoing war, the sanctions, and of events to come, remain highly uncertain.” “Making appropriate monetary policy in this environment requires a recognition that the economy evolves in unexpected ways.” Powell told the Senate Banking Committee last week “In this very sensitive time at the moment, it’s important for us to be careful in the way we conduct policy simply because things are so uncertain and we don’t want to add to that uncertainty.” Rate hikes will “slow economic activity gradually” as economy-wide borrowing costs would eventually curb inflation. Futures markets see the Fed funds rate topping out at only 1.75%-2% next year, below the Fed’s estimated 2.5% long term neutral rate.

New Jersey Wins Credit Upgrade… New Jersey bagged its first credit upgrade in 17 years last week. Moody’s raised its rating one notch to ‘A2’ with a stable outlook. S&P and Fitch carry a positive outlook on New Jersey bonds rated ‘BBB+’ and ‘A-’ respectively. New Jersey’s previous upgrade in 2005 was followed by 13 downgrades between 2011 and 2020. Moody’s attributed the upgrade to historic pension contributions from surplus funds and completion of a debt reduction program, which is consistent with improving governance and fiscal management. The improved credit rating would lower New Jersey’s borrowing costs. New Jersey State Treasurer said the upgrade “provides further evidence that we are taking the right steps on our continuing path toward fiscal security.” Governor Murphy stated “Our efforts to build New Jersey’s credit rating back up from decades of downgrades have yielded another positive result.”

Moody’s Upgrades Chicago Board of Education… Moody’s upgraded Chicago Board of Education (‘CPS’) credit to ‘Ba2’ from ‘Ba3’, with a stable outlook. Growing state aid, massive federal relief aid, and stable property tax receipts, and increasing real estate valuations are behind the rating boost. As the district’s operating fund balance has grown to $804 million in fiscal 2021 from $567 million in 2020 and negative $275 million in 2017, it has trimmed its annual cash-flow borrowing over the last four years. Federal aid, $2.8 billion, will be exhausted in September 2024. Expense controls will be necessary for the junk-rated school district, which is two steps away from a Moody’s investment grade rating. Fitch’s December 2021 upgrade to ‘BB+’ has landed CPS one-notch below investment grade. Most new CPS bond issues came without a Moody’s rating in recent years. That could change with last week’s positive rating action.

Could California See A Rating Upgrade… The Golden State’s credit rating could be ripe for a rating upgrade. A sizeable discretionary surplus, continuing revenue outperformance and lower debt has made California finances stronger. California “is the strongest it has been in decades,” a CreditSights analyst said it likely deserves the second- highest rank of AA+. California is selling $2.2 billion municipal bonds next week, the state’s first general obligation bond sale in two years. Seven weeks of outflows from municipal bonds funds, driven by rate hike plans, have brought down prices of municipal bonds. All eyes will be on the new issue Golden State bonds to see what they fetch in tax-free yields.

Connecticut’s Surplus… “I’m not one for hyperbole, but I think we’re in the best financial shape this state has been in in a long time,” Governor Lamont stated. Connecticut’s rainy day fund has grown from $1.2 billion when the governor took office in January 2019 to a record-setting $3.1 billion now, the statutory maximum. Connecticut received $3 billion in federal direct aid, of which $2.8 billion is in the budget. Lamont’s $24 billion Fiscal 23 state budget is 2.5% higher than prior year. Analysts are projecting the current fiscal year’s surplus to be nearly $2.5 billion , and that state finances may no longer be in deficit in 2024, when the federal aid runs out. Last year, Connecticut won its first rating upgrade in two decades.

Puerto Rico Revenue Outperforms… Puerto Rico tax collections outperformed expectations by 22% or $940 million in the first half of Fiscal 22. Sales tax collections, the biggest revenue generator totaling $1.1 billion through December, outperformed forecast by $195 million. The Island’s Treasury Secretary stated, “These are positive economic indicators, but they do not rule out the current challenges we face, such as the implementation of structural reforms and the reformulation of our tax system, toward a simpler and more equitable one.” Meanwhile, the Island’s teachers have sought the U.S. Court of Appeals of the First Circuit for a stay on the Title III court approved central government plan of adjustment, which is set to become effective in mid-March. The U.S. Court of Appeals will hold a hearing this week.

More ESG Municipal Bonds… U.S. states and cities will likely sell a record amount of sustainability-linked municipal bonds this year. About 13% of new municipal bonds issued this year could be for green, social or sustainable purposes. From being virtually non-existent a decade ago, environmental, social or governance (‘ESG’) based municipal bond issuance has grown. This year’s ESG bond tally could be $60 billion, up from $46 billion last year and $27 billion in 2020. The affordable housing sector has seen large ESG deals, including $4.2 billion from one California authority last year. A bond is designated green or social based on certain criteria put forward by independent organizations. As the sector evolves, U.S. regulatory agencies are developing disclosure requirements for bond issuers. Green bond issuance may not provide any pricing benefit to municipal issuers, but brings a broader investor base for states and cities.

Compare 30-Year taxable U.S. Treasury yield 2.18% to 30-Year tax-exempt muni bond yield “AAA” 2.05%; “AA” 2.41%; “A” 2.64%; “BBB” 3.07%. For investors in the 35% tax-bracket, a 3.07% tax-exempt yield is equivalent to a 4.7% taxable yield. Top rated tax-free bonds yield 94% of comparable taxable U.S. Treasuries.