Week of 5/16/2022

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Higher Municipal Bond Yields…Investors Mull Fluid Inflation…California’s Record Surplus… Connecticut Boosts Pension Contributions…U.S. States Win Sports Betting Wager…Bally’s Wins Chicago Casino Bid… Muni Bond Rating Upgrades Outpace…

Higher Municipal Bond Yields… The rout in financial markets has sent municipal bond prices to historically cheap levels. 30-year tax-free state and local government debt yields 3.28%, which is 128 basis points or 64% more than after-tax yield of 2% on comparable taxable long-term U.S. Treasuries. Municipal bonds’ higher yields are now appealing to even to ‘cross-over’ buyers, who are non-traditional investors that do not value municipal bonds’ tax advantage. Municipal bond indices have lost over 10% this year, comparable to routs in March 2020 Covid-19 related sell-off, October 2008 financial crisis and November 1994 rapid rate hikes. For thirteen straight weeks, investors have pulled out cash from municipal bond funds. Municipal bond yields are more than 180 basis points higher on the 10- and 30-year since the start of 2022, and performance improves after 100 basis point sell -offs, “at least historically,” Bank of America Merrill Lynch noted that sell-offs of this magnitude have happened in as many days only six other times since 1993, with returns over these periods were negative, to be followed by strongly positive returns over the next year or so. Will history repeat this time around? With the Muni-Treasury ratio, a gauge of relative value, at multi-year highs, this year’s municipal bond losses have been termed as an ‘over-correction’.

Investors Mull Fluid Inflation… Broader price pressures continue. Some COVID-related price surges could buckle down, but some higher prices could be ‘sticky’. Inflation accelerated 8.3% from a year ago, a slowdown from the prior month but still among the fastest in decades. A slew of items are seeing price surge, for example, airfares soared 18.6% in April from a month ago, as demand outstrips seat supply. But potentially lower future shipping costs could be in the pipeline as backlogs at major California ports are beginning to clear up signaling potential easing of supply chain disruptions. The Port of Los Angeles recorded last month as the second busiest April in history. Used car and truck prices are up 24.8% from a year ago, relative to a 45% year-over-year price hike in early 2022. Energy prices dropped 2.7% in April, after jumping 11% in March. The housing sector is cooling, as existing home sales dropped materially for the second straight month on the heels of lower purchasing power impacted by rising mortgage rates and inflation, although headline housing starts and building permits edged higher in March. Yields on nominal and inflation-adjusted U.S. Treasuries implies an average inflation of 2.9% over the next five years, and 2.6% over the following five. There is a long list of inflation risks, including lockdowns in China, Russia’s invasion of Ukraine, the invasion’s impact on energy and food prices, and a tight labor market. The Federal Reserve is not going to abandon its plan to aggressively remove monetary policy accommodation even if inflation has peaked. Fed Chair Powell stated last week, “The process of getting inflation to 2% will also include some pain…” Federal Reserve has more ‘wood to chop’ to lower inflation and odds of a ‘soft landing’ are declining.

California’s Record Surplus… A record-smashing surplus of nearly $100 billion is part of California’s Fiscal 23 budget. Fueled by surging tax revenue, Governor Newsom unveiled a revised budget plan of $300 billion, the highest in California’s history. The state has collected $55 billion more in taxes than officials expected in January. Nearly half of the Golden State’s personal income tax collections are paid by the top 1% of earners. Capital gains’ contribution to personal income is at levels last seen pre-2000. California finances tend to be tied with economic cycles. More than 90% of the surplus would go one-time spending items. Newson proposes paying off $3.5 billion bonds early, and using cash instead of selling state bonds to finance some capital projects. State legislature must approve the budget by June 15. The surplus is “simply without precedent,” says Newsom, a first-term Democrat eyeing re-election this year.

Connecticut Boosts Pension Contributions… A big chunk of Connecticut’s $4.8 billion projected surplus will lower Connecticut’s unfunded pension liability, while some would fund a historic tax cut. Governor Lamont (D) signed a $24 billion spending plan approved by the Democrat-majority legislature, that boosts general fund spending by 6.5%. Between the projected surplus of $4.8 billion and the $3.1 billion budget reserve, Connecticut has amassed a cushion of nearly $8 billion. With more than $95 billion of long-term liabilities tied to pensions, retirement benefits and bonds, Connecticut’s per capita debt ranks high among U.S. states. Governor Lamont’s debt reduction initiatives along with improved reserves earned Connecticut its first ratings upgrade last year. Connecticut plans to sell $1 billion general obligation bonds this month.

U.S. States Win Sports Betting Wager… In 2022, tax revenue from sports betting and casinos continued on a winning streak nationwide. Gaming revenue, $14.3 billion nationwide in the first quarter of 2022, has accelerated nearly 29% from a year ago. Sports betting and online wagers hit all-time quarterly highs. For brick-and-mortar casinos, seventeen of 25 states saw revenue exceed pre-pandemic levels. 34 U.S. states and the District of Columbia have legalized gaming, with Kansas being the newest last week. New York State has quickly shot up as a top-ranked gaming market after it legalized sports betting last year, raking in $1 billion of quarterly gaming revenue in close competition with neighboring New Jersey. Nevada continues to lead the race with over $3.5 billion of quarterly revenue. High inflation has not put a dent on sports betting spending, and U.S. states that legalized gaming are laughing all the way to the bank.

Bally’s Wins Chicago Casino Bid… Chicago selected Bally’s to develop a $1.7 billion casino at the riverfront in the Loop Business District by 2026. The casino complex will include a hotel, recreation venues, parks, slot machines and table games, that could see some 4.5 million visitors annually. Some slot machines could be allocated to Chicago’s two airports. Bally’s outscored rival bids due to its labor agreement and upfront $40 million cash. The casino could bring over $200 million annually to city coffers. City council and Illinois Gaming Board must approve. Illinois taxes casinos at the highest rate among U.S. states.

Muni Bond Rating Upgrades Outpace… For the fifth quarter in a row, municipal bond upgraded by Moody’s outpaced downgrades. In Q1-22, the number of municipal bond issues that received ratings Moody’s upgrades were three times relative to downgraded bonds. Local governments accounted for three-quarters of Moody’s recent rating actions. Notably, lower-rated U.S. states including New Jersey and Illinois have been rewarded with ratings upgrades. A steady spate of favorable rating actions highlight the credit stability of the $3.9 trillion municipal bond market.

Compare 30-Year taxable U.S. Treasury yield 3.08% to 30-Year tax-exempt muni bond yield “AAA” 3.28%; “AA” 4.01%; “A” 4.24%; “BBB” 4.33%. For investors in the 35% tax-bracket, a 4.3% tax-exempt yield is equivalent to a 6.6% taxable yield. Top rated tax-free bonds yield 106% of comparable taxable U.S. Treasuries.