Week of 5/23/2022

Chicago Outlook Improves… Illinois Bonds Oversubscribed…New York City Bonds Oversubscribed… PREPA Eyes Lower Fuel Costs…State Infrastructure Upgrades… Mixed Growth/Recession Odds… Attractive Municipal Bond Valuations…

Chicago Outlook Improves… A much lower budget gap for next year than earlier anticipated shapes an improving outlook for the Windy City. Chicago is looking at a $306 billion budget gap in 2023, defying a $867 million budget gap forecast last year. Chicago could end 2021 with a surplus of $250 million, as tax revenues outperformed and expenses remained steady. A budget deficit of $306 million would be the lowest shortfall since 2019, when former Mayor Rahm Emanuel closed a $97.9 million gap. In 2020, the city closed a budget gap of $838 million, followed by a $1.2 billion budget gap in 2022. Federal aid, growing revenue and expense cuts wiped out a budget gap of $733 million in 2022. Such a small 2023 budget gap would outperform the city’s rosiest forecast. A hot real estate market deserves credit for much of the revenue outperformance, and income tax collections have been rosy. Chicago’s property tax collections are poised for a boost from Cook County’s triennial assessment that imposes a 75% hike on commercial properties, about three times the hike on homeowners. Also, City administration has set aside $152 million from excess federal COVID-19 aid. Chicago also reached a pension funding milestone as all four city pension funds received actuarially based contributions from the city in 2022. Chicago’s net pension liabilities are around $33 billion, with low funded ratios ranging from 19% to 44%. The improved financial outlook could be a boon for Mayor Lightfoot, facing re-election this year.

Illinois Bonds Oversubscribed… Over $5 billion worth of orders for $1.6 billion new issue Illinois general obligation bonds reflects high demand for the recently upgraded state bonds. “The state of Illinois was very pleased to see such a strong reception from more than 90 different investors, including 30 new names, resulting in $5 billion of orders and 3 times oversubscription during one of the most turbulent markets in years,” Illinois Capital Markets Director stated. Illinois offered 2037 and 2028 maturities at premium 5.25% coupons and the 2042 and 2047 maturities came with 5.5% coupons. Long term bonds yielded about 4.8%. About half of the new bonds will refund higher cost prior debt, bringing significant interest savings for the lowest-rated U.S. state. Despite three ratings upgrades recently, Illinois yield gap relative to top-rated tax-free benchmarks has shot up this year as the war in Ukraine, rising inflation, and Federal Reserve actions have created a high interest rate environment, with the 10-year taxable U.S. Treasury hovering near 3%. Illinois general obligation bonds yield around 130 basis points more than top-rated municipal benchmarks, almost double from six months ago when Illinois’ yield penalty was the lowest in more than a decade.

New York City Bonds Oversubscribed… New York City received approximately $4.2 billion of priority orders, representing just over 7.1x the amount of tax-exempt bonds offered for sale to institutional investors. Investor demand brought yield cuts of up to 10 basis points for long term bonds. Final tax-exempt yields ranged from 2.49% to 4.64%, while yields for taxable tranches ranged from 3.732% to 4.193%. “NYC is in better-than-expected financial condition made possible through historic federal relief, as well as strong revenue collections.” City controller stated. Recovery from pandemic-related woes and reserves mitigate uncertainties for the high grade city, which faces slower commercial real estate growth and lagged employment recovery relative to national levels. The bond sale came on the heels of Fitch rating outlook boost from stable to positive.

PREPA Eyes Lower Fuel Costs… The war in Ukraine has not left the Island Territory unscathed. Escalating fuel costs means Puerto Rico’s sole electric utility could pay twice as much for fuel costs than earlier estimated. PREPA could lose about $170 million from April to July 2022. It is high time for the electric utility to seek renewable alternatives that insulate from rate hikes in oil and natural gas, and it must get a better handle on accurate fuel cost reporting and estimation, energy experts reckon. Luma Energy, the private operator running electric transmission and distribution has also taken flak for PREPA’s budget overages, and some lawmakers want to end Luma’s 15-year contract. By 2024, the Island could derive 24% of its energy from alternative fuels, up from 3% now, if renewable energy agreements, conditionally approved by the oversight board this year, come to fruition. When asked if the deficits might affect the PREPA’s ability to pay its legacy bonds, Puerto Rico’s fiscal agency said, “This timing difference doesn’t relate to PREPA’s ability or inability to pay its bonds,” adding that the Puerto Rico Energy Bureau “reconciles and resets the fuel and purchased power adjustment charges in customer rates on a quarterly basis.” The Oversight Board and bondholders are currently in negotiation over the PREPA’s $8 billion in bond debt.

State Infrastructure Upgrades… Over $100 billion federal dollars have been sent to states and local governments in the past six months, and another $100 billion is imminent. States are spending the bulk of the money on transportation, followed by climate, energy and environment projects. President Biden signed the bipartisan $1.2 trillion IIJA Act in November 2021. Since then, inflation has shot up to 40-year highs and labor force has contracted, a roadblock for implementing capital plans. California has seen the biggest chunk, at $9.7 billion, followed by New York at $6.7 billion.

Mixed Growth/Recession Odds… Wall Street cut growth forecasts and elevated their outlook for risks, but a chorus of economists predicts that U.S. economic growth will outperform advanced nations during the next three years. The U.S. unemployment rate is poised to reach 3.5% in the third quarter, the lowest in five decades, and it will remain low for several years. Ten U.S. states hit record low unemployment. A tight labor market along with supply chain pressures continue to put upward pressure on wages. “We are growing increasingly pessimistic about next year as key inflation indicators continue to hint at a larger persistent component, and severe overheating in the labor market continues,” Bank of America analysts noted. Last week, J.P. Morgan Chase & Co. lowered growth estimates, and Goldman Sachs sees 35% odds of a recession over the next two years. The median forecast of 69 economists puts the CPI at an average of 7% this year, before it falls to 3% in 2023 and 2.4% in 2024 per a Bloomberg survey. “Powell said, “What we need to see is inflation coming down in a clear and convincing way, and we’re going to keep pushing until we see that.”

Attractive Municipal Bond Valuations… 30-year tax-exempt bonds yield 110% of comparable taxable U.S. Treasuries, the highest this year and a level last reached in late October 2020 and August 2015 prior. The current sell -off in the municipal bond market is reminiscent of the ‘taper tantrum’ of 2013, when outflows continued from March 2013 to January 2014, but muni-treasury ratios began stabilizing before that, Barclays said. Bank of America analysts note that the municipal bond market sell-off has reached an important milestone with most long-term top-rated benchmark tax-free yields higher than the March 2020 COVID-19 related sell-off.

Compare 30-Year taxable U.S. Treasury yield 3.03% to 30-Year tax-exempt muni bond yield “AAA” 3.34%; “AA” 3.84%; “A” 4.29%; “BBB” 4.35%. 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 110% of comparable taxable U.S. Treasuries.