Week of 6/10/2019
Seema Balwada, CFA
Director of Research
Seema Balwada, CFA
Director of Research
Rate Cuts Coming… 10-Year Treasuries Forecasted To Yield Less Than 1.5% By Year End…Favorable Puerto Rico Fed Aid Package…Bondholders Question Puerto Rico Huge Cash Stockpile…Connecticut Delivers Balanced Budget…Illinois Budget Alleviates Rating Risk…California Nears Balanced Budget Deal…Bipartisan Bill Could Close Affordable Housing Shortage With Tax Free Munis…Long Term Munis Attractive As Rate Cuts Appear Imminent…
Rate Cuts Coming…Sharply lower job growth in May could jolt the Fed to cut rates sooner. In May, the U.S. economy added 75,000 new jobs, less than half of expected and about a third of 2018 levels. April and March new jobs were revised downwards. Lower payrolls on the heels of softer retail sales, factory output, and home purchases could be precarious for the U.S. economy fraught by a two-fronted trade rift with China and Mexico. “We will act as appropriate to sustain the expansion,” Fed Chair Jerome Powell stated this week the Fed intends to preserve the longest expansion in U.S. history. Separately, St. Louis Fed President James Bullard and San Francisco Fed President Mary Daly said conditions may soon warrant a rate cut. The bond market expects 70 basis points of rate cuts by the end of 2019 and four rate cuts by 2020. A July rate cut is expected with 87% certainty.
10-Yr Treasuries Forecasted To Yield Less Than 1.5% By Year End…The future path of the benchmark U.S. Treasury yield, at a 21-month low, is predicated by the speed and trajectory of the Fed’s rate cuts. 10-Year U.S. Treasury bonds hit new 2019 lows near 2% down from 3% at the end of 2018. In July 2016, the 10-year Treasury hit an all-time low of 1.36%. Major world central banks are looking at a cycle of rate cuts, and growing stockpiles of negative yielding debt add to the prices of safe-haven U.S. Treasury bonds. Record low Treasury yields are forecast by some economists looking at an aggressive rate cut scenario; 10-year Treasury yields could drop to 1.25% by year-end, a drop of almost a percentage point from the current level of 2.12%, Commerzbank predicts. The bond market expects the short-term Fed Funds rate to be 1.7% by year-end down from 2.37% now. The Fed’s June 18-19 meeting is likely to feature debate on the rate cut decision tree followed by a decision in a July meeting. Once the Fed begins its cycle of rate cuts, its path forward could determine how low benchmark Treasury yields could go.
Favorable Puerto Rico Fed Aid Package…Puerto Rico will receive $1 billion from the $19 billion Federal disaster aid package signed into law by President Trump. The aid package includes $600 million for its food stamp program and $300 million for community block grants. The aid package also expedites the release of $8.9 billion already approved by Congress for Puerto Rico disaster relief. The disaster aid package had become a bone of contention amid politicians settling scores on major national issues. Federal disaster aid is much prized in Puerto Rico and is the cornerstone of its economic rebound.
Bondholders Question Puerto Rico Huge Cash Stockpile…Puerto Rico’s growing cash coffers reflects its ability to repay bondholders. Puerto Rico’s Treasury is awash with cash liquidity. Close to $7 billion cash, or $2.2 billion more than expected, is in the Treasury’s central account as the Island’s tax collections have soared along with its economic growth. Additional $14 billion is in various bank accounts of government agencies; these accounts are under an Oversight Board mandated forensic investigation. Puerto Rico’s growing cash coffers repudiates the Oversight Board’s call for the Island to walk away from certain general obligation and appropriation bonds in Title III bankruptcy. Bondholders question the glaring cash hoard that has come at their expense. Cash, a yardstick of finances, is a central part of ongoing on general obligation bond restructuring negotiations.
Connecticut Delivers Balanced Budget…A two-year $43 billion budget for fiscal 20 and fiscal 21 closed a projected deficit of $3.7 billion. The budget brings in about $2 billion in tax increases over two years from a pass-through entity tax paid by wealthy owners of privately held businesses, a mansion tax on certain high-end home sales, a hospital provider tax settlement and broadening the state sales tax net. Spending growth is lower than in past years and includes savings from state retiree healthcare. State aid to cities and towns has not been cut. Connecticut’s rainy day funds, $2.6 billion likely, could almost double from a prior peak reached over a decade ago. The budget does not hike sales tax or income tax and smooths a teacher pension cliff over more years. “This budget is fair, balanced and promotes economic growth.” Governor Lamont added, “Most of all, the budget further stabilizes our state’s finances”.
Illinois Budget Alleviates Ratings Risk…Illinois has marginally built on strengths in the past year, Moody’s noted that the accomplishments of the 2019 legislative session show an improved political climate as it affirmed its “Baa3” credit rating on Illinois general obligation bonds. An S&P analyst commented, “The fiscal 2020 budget signals near-term credit stability and buys the state more time to address out-year gaps.” Illinois faces fiscal pressure from its pension funding requirements outpacing revenue growth. A Fitch analyst said, “It was incredibly beneficial for fiscal 2019 and fiscal 2020 by alleviating some pretty significant near-term pressures”. Now that Illinois has turned the page on several years of budget discord with an on-time bipartisan budget, rating agencies are looking for structural balance from sustainable revenues.
California Nears Balanced Budget Deal…Broad outlines of Governor Gavin Newsom’s first budget were unveiled. Bipartisan agreement on main ideas and talks on language are ongoing as lawmakers are expected to vote on the parts of the spending plan later this week in time to meet their constitutional deadline of June 15. Newsom said, “The budget adopted by the Conference Committee is balanced, creates historic reserves and expands budget resiliency.”
Bipartisan Bill Could Close Affordable Housing Shortage With Tax-Free Munis…A niche of the municipal bond market, multifamily housing bonds could see higher supply or issuance volume if proposed legislation is approved. A bipartisan bill aims to close the shortage of affordable housing across the nation by offering more federal tax breaks to developers. If enacted, the bill known as ‘American Housing Credit Improvement Act of 2019’ expects to create 1.9 million additional affordable units over the next decade. About half of multifamily housing units that use federal tax credits are financed with tax-exempt private activity bonds. For the last two years, roughly $21 billion of housing bonds were issued annually. A municipal bond specialist must evaluate investments in tax-exempt bonds backed by revenues of multifamily affordable housing projects. Multifamily housing bonds carry unique risks and offer extra yield for a welldiversified bond portfolio.
Long Term Munis Attractive As Rate Cuts Appear Imminent…$10 billion of new issue tax-free bonds will pique the interest of bond buyers since weak supply has been the norm this year. For the 22nd week in a row, investors purchased municipal bonds and inflows have exceeded $1 billion each week for the past month. Puerto Rico, New York, Georgia, and Iowa bonds were most actively traded and California bonds saw much interest last week. With more new issues to pick from, attractive prices of long term munis (30-year tax-free munis yield about 92% of taxable U.S. Treasuries) are likely to trigger investments as investors prepare for the upcoming Fed rate cutting cycle.
Compare 30-Year taxable U.S. Treasury yield 2.61% to 30-Year tax-exempt muni bond yield “AAA” 2.40%; “AA” 2.56%; “A” 2.69%; “BBB” 3.15%.