Week of 5/28/2019

Illinois Bond Gains Outpace Allther States… Restructured Puerto Rico Bonds are Outperforming the Municipal Bond Market While Other Puerto Rico Bonds Face More Challenges…Credit Positive California Budget Delivers Gains…Chicago Mayor Aligns With Illinois Agenda…High Yield Muni Bonds Continue to Outperform…Worldwide Economic Slowdown Could Spur Lower Safe Haven Bond Yields…

Illinois Bond Gains Surpass…Returns on Illinois general obligation bonds outpaced every other U.S. state in May 2019. Illinois bonds have returned 5.34% this year and 1.41% in May alone. Illinois bond gains exceed U.S. state general obligation bond benchmark returns of 3.82% this year. The gains come as Governor Pritzker’s proposed constitutional amendment to allow progressive income tax rates continues to advance in the state legislature. Illinois House Revenue and Finance Committee pushed the Democrat governor’s bill forward to the House floor with all Democrat votes. A unified party-line vote had gained Senate approval for the pivotal tax reform plan. Before voters can decide at the November 2020 ballot, it must gain 71 House votes from amongst 74 Democrats in the Illinois House. “What this gives us in Illinois is the opportunity to solve our financial problems and eliminate our structural deficits,” the bill’s House sponsor Rep. Martwick (D) explained at a House hearing. Separately, Illinois plans to revamp state infrastructure with a $41.5 billion six-year capital plan that relies on a fuel-tax hike, liquor/gambling tax hikes, federal, local and private funds and $17.8 billion bond issuance. A change of guard for the lowest-rated U.S. state has opened up avenues for much-needed fiscal reform and boosted investor confidence. Illinois bonds yield about 1.4% more than top-rated munis – the yield penalty or gap relative to top rated munis has dropped to less than half from a 3% peak in 2017.

Restructured Puerto Bonds are Outperforming the Municipal Bond Market While Other PR Bonds Face More Challenges…Puerto Rico bonds have returned an average of 9.6% this year, outperforming all other municipal bonds. Major high yield bond funds such as Nuveen, PIMCO and Alliance Bernstein, who boosted holdings of Puerto Rico bonds in recent months, have favored debt backed by special revenues including debt issued by the Island’s water utility PRASA, electric utility PREPA and COFINA. Puerto Rico’s general obligation bonds, pension bonds, and public building authority bonds could face higher complexity. Puerto Rico’s Oversight Board seeks to recover or claw back debt service paid over four years from 2013-2017 to large scale bondholders, owning more than $2.5 million of challenged bonds issued by the Commonwealth, Employee Retirement System and Public Building Authority agencies. The Oversight Board’s claim that certain general obligation bonds, public building authority and pension bonds were issued illegally confounds investors who relied upon the contract of the trust indenture and bond official statement. The Island’s treasury cash balance, $6.5 billion in May 2019, exceeded the Island’s projections by $1.7 billion reflecting an upswing in government revenues and the Island’s rebound from Hurricane Maria. Although COFINA and GDB have emerged from Title III debt restructuring, much of the island’s debt backed by general government revenues is mired in controversial politics.

Credit Positive California Budget Delivers Gains…California, a state pundits declared bankrupt not too long ago, merits an upgrade to Aa2 from Aa3 from Moody’s per Bank of America Corp strategists because “the state is a materially different one than then and likely warrants an upgrade to Aa2,” Bofa referred to the Golden States’ 2014 Moodys upgrade. In May, Governor Gavin Newsom revised substantially upwards general fund revenues for fiscal 2019 and fiscal 2020. Higher revenues allow more funding to California’s school districts and community colleges and help with teachers’ pensions, a credit positive per Moodys. Along similar lines, Fitch noted California’s strong budget management and an extended period of economic recovery and expansion. This year, California general obligation bonds have returned 4.3% outpacing U.S. state bond benchmark return 3.8%.

Chicago Mayor Aligns With Illinois Agenda…A casino in Chicago, state help with Chicago pensions and an infrastructure bill are at the top of Mayor Lightfoot’s wish list for Illinois lawmakers. Mayor Lightfoot stated, “So we’re firing on a lot of different cylinders to make sure that the city of Chicago gets its fair share of resources from Springfield”. The new Mayor supports Governor Pritzkers’ higher taxes on the wealthy. Mayor Lightfoot wants to align Chicago’s fiscal issues with the State and asks that “Chicago’s fiscal circumstances have to be part of the calculus as well, and I think they get that.” Chicago’s new Mayor, Lori Lightfoot, and her finance team have rolled up their sleeves to measure the “size and depth” of the fiscal challenges confronting the low rated Windy City. Bondholders are looking for an open line of communication from the new mayor who took reins of Windy City finances last week.

High Yield Municipal Bonds Continue to Outperform…Strong demand for lower-rated non-investment grade rated tax-free bonds has led non-investment grade rated bonds to outperform. Returns for lower rated muni bonds, 5.5% this year, have outperformed top rated tax-free bonds 3.76% return and 2.99% return for taxable U.S. Treasuries. New issues of tobacco bonds, airports, hospitals and health-care projects carry higher risks and potentially higher rewards. Higher demand for high yield munis comes amid higher prices for top-rated tax-free munis which yield over 90% of taxable U.S. Treasury debt. For five months, investors have increased holdings of municipal bonds. In the 20th straight week of inflows to the muni market, investors added $1.5 billion of munis with a third of the investments for high yield munis. As muni bond prices have gained this year, high yield munis have found a sweet spot with investors.

Worldwide Economic Slowdown Could Spur Lower Safe-Haven Bond Yields…The path for further drop in U.S. bond yields or bond price gains could open up from the rush to safe-haven U.S. Treasuries. Higher supply of negative yielding bonds abroad shapes the inflows towards positive-yielding U.S. Treasuries. The volume of negative-yielding bonds, $10.6 trillion outstanding issued overseas, has almost doubled in the last six months and displaces fears of Chinese push back on U.S. Treasuries. Last week, U.S. Treasury yields hit the lowest since 2017. Signs of a second quarter slowdown include lower U.S. factory activity amid the tariff war with China. Sales of new U.S. homes cooled in April from an 11- year high amid a surge in prices. Most of the sales decline came in homes priced below $300,000, reflecting lower pricing power in the housing market despite lower mortgage rates. The economy appears to be at the dividing line between expansion and contraction. The Atlanta Federal Reserve Bank’s GDP Now model estimates that the U.S. economic is growing at a 1.3% annual pace in the second quarter or 40% of first quarters 3.2% growth rate. Bank of America Merrill Lynch predicts that the benchmark U.S. Treasury 10-year yield could fall around 2.06% as the current yield broke below the 200-day moving average. Fed fund futures predict a downward path for interest rates that could bring as many as two interest rate cuts this year.