Week of 8/23/2021

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Economy Prospects Downgraded… Fed Plans Tuned to COVID-19 Risks… Puerto Rico Utility Bonds Score Low Yields… Puerto Rico Revenue Outperforms 33%… States’ Cash Cushion… Finding New Municipal Bonds…

Economy Prospects Downgraded… A sharp cut in economic growth ahead is flagged by signs of slackening consumer confidence. Goldman Sachs cut in half its third-quarter economic growth forecast to 5.5% down from 9%. “Spending on dining, travel and some other services is likely to decline in August, though we expect the drop to be modest and brief,” Goldman Sachs observed that the impact of the Delta variant is proving to be “somewhat larger than expected.” The University of Michigan index of consumer confidence fell 13.5 % in the month to mid-August, dipping below the lows reached in April 2020 during the early days of the pandemic. The only other fall of this magnitude occurred during the depths of the global financial crisis in April 2008. “Consumers have correctly reasoned that the economy’s performance will be diminished over the next several months” by the spread of the Delta the report said. “Covid-19 risks are reemerging as a really important downside risk,” Barclays echoed “It is back on the Fed’s radar and the wording in the minutes gives them the freedom to put a hold on tapering.” Moody’s weekly business confidence index also suggests that the “Delta variant may be biting”. The economy is expected to grow 6.3% this year, down from 6.7% Moody’s July estimate, tapering down to 2.3% by 2023. Plans to end extended unemployment benefits in September could cast a long shadow on future spending. Since vaccines arrived, a growing consensus to downgrade future economic growth is taking hold for the first time.

Fed Plans Tuned to COVID-19 Risks… Discussions around tapering Federal Reserve bond purchases were revealed in Fed minutes released last week. “Most participants noted that, provided that the economy were to evolve broadly as they anticipated, they judged that it could be appropriate to start reducing the pace of asset purchases this year,” the minutes said that some Fed officials prefer waiting longer until early next year for stronger evidence of healing from COVID-19. Some Fed officials noted recent slow hiring progress is a dampener to economic recovery. Amid Delta variant concerns, retail sales showed spending slowed last month, while credit card data show further deterioration this month. The Fed has stressed that it will provide plenty of advance notice before policy action. Timing, pace and composition of scaling back Federal Reserve bond buys are yet unknown.

Puerto Rico Utility Bonds Score Low Yields… Puerto Rico’s water utility, PRASA, cut borrowing cost by almost 100 basis points since December. New $1.7 billion 5% coupon bonds maturing in 2037 fetched 2.82%, down from a 3.95% yield for similar dated bonds issued in December 2020. Investors sought about 166 basis extra yield relative to top rated benchmarks, down from about 300 basis point spread last year. Favorable borrowing costs allowed the water utility to save $570 million in debt service through 2047. A Puerto Rico fiscal agency official stated “This bond issue is one of the biggest financial achievements since the enactment of PROMESA, as it demonstrates that PRASA once again has been able to access the institutional capital markets at reasonable rates and regained market confidence.” Spared from the Island’s Title III bankruptcy, Puerto Rico water utility’s proven market access bears testimony to investor demand for high yield tax-free bonds.

Puerto Rico Revenue Outperforms 33%… The Island’s Fy2021 general fund revenue, $12.3 billion, is $3 billion or 33% higher than Oversight Board projection. Massive federal stimulus fueled the outperformance. Puerto Rico’s general fund took in $2.5 billion from sales taxes, about $125 million more than anticipated for its largest revenue source, after full payment of COFINA bond annual debt service. The outperformance has boosted the Islands’ cash to record levels, $25 billion, three times the amount when it was first unearthed during the Title III court process. Puerto Rico Oversight Board members are talking about a “grand bargain” with the local legislature. Such a deal may include additional pension payments in exchange for the Island legislature’s approval of new bonds and electric rate increases. A “grand bargain” could be a way of getting approval of a workable PREPA agreement and completing the central government debt deal.

States’ Cash Cushion… Coffers of U.S. states are flush with cash. Billions of dollars of revenue outperformance are a far cry from March 2020 when COVID-19 related federal aid was first pressed into service. States have several years to put the federal aid to work. The Treasury has already distributed about $238 billion of aid to states and local governments, or 97% of what’s eligible to be released so far. At least 10 states, including Georgia, Missouri and Texas, haven’t spent any of the state aid under the legislation. Michigan has budgeted just 7% of its $6.5 billion allocation and hadn’t spent any so far. A special legislative session will determine how Texas could best use its federal aid. Across the nation, townhalls, constituent surveys and political agendas are shaping multi-year use of federal aid for the most impact. With plenty of federal aid sitting in state bank accounts, money is not a pressing issue.

Finding Municipal Bonds… One-third of outstanding municipal bonds will mature or be called for early redemption in the next five years. Finding new muni bonds to replace tax-free income is increasingly difficult. New issues of municipal bonds, $289 billion so far this year, have not kept pace with municipal bond demand. Investors have added cash of more $69 billion to municipal bonds this year, of which a quarter has sought high yield municipal bonds that boast outperforming index returns, 7.3% this year. Recently, several high yield bond funds have closed to new investors due to a shortage of municipal bond supply. New municipal bonds issued in the primary market are deeply oversubscribed and yields are cut with investors scrambling to get a piece of tax-free paper.

Compare 30-Year taxable U.S. Treasury yield 1.88% to 30-Year tax-exempt muni bond yield “AAA” 1.53%; “AA” 1.72%; “A” 1.98%; “BBB” 2.29%. For investors in the 35% tax-bracket, a 2.2% tax-exempt yield is equivalent to a 3.4% taxable yield. Top rated tax-free bonds yield 81% of comparable taxable U.S. Treasuries.

If you have any questions or desire updated information contact your GMS Account Executive.