Week of 8/26/2019

September Rate Cut Expected… Premium Bonds Favored By Muni Bond Portfolio Managers… Fewer Insured Bonds… Judge Slams Puerto Rico’s Spending Law… New Jersey Law A Boost For Local Government Cash Flow… Connecticut Bonds Rally… State Help, More Taxes Sought by Chicago Mayor… Weak U.S. Manufacturing Amid Global Cooling…

September Rate Cut Expected…Markets reflect a 25-basis point fed fund rate cut in September is almost certain. A 50-basis point rate cut will come under ‘robust debate’ on the upcoming September 18 Fed meeting, St. Louis Fed President James Bullard noted. President Trump advocates for a full 1% rate cut amid a global cycle of rate cuts. Fed Chair Powell reiterated that slowing global growth, trade policy uncertainty, and muted inflation cloud the economic outlook. At Jackson Hole, WY this week, Fed Chair Powell repeated the pledge that the Fed “will act as appropriate to sustain the expansion.”

Premium Bonds Favored By Muni Bond Portfolio Managers…For many individual investors the Premium Bond is one of the most misunderstood of all fixed income investments. However, for institutional investors Premium Bonds, sometimes called a defensive investment, are currently one of the most sought after fixed income investments. Fixed income bonds with interest rates higher than current market rates are priced above 100 and are therefore called “Premium Bonds”. Since a Premium Bond will mature at 100 or in the case of a call or pre-refunding at a smaller premium than the investor paid, many individual investors mistakenly assume that the premium paid is an irrecoverable loss of principal. What makes Premium Bonds sought after and very attractive to fixed income portfolio managers? If you would like to discuss the value of Premium Bonds and consider current Premium Bond offerings, contact your GMS account executive.

Fewer Insured Bonds…Fewer insured bonds are available in the bond market. The insured muni bond market comprising $277 billion outstanding muni bonds has shrunk to a third since 2014 when $900 million insured muni bonds were outstanding. In the new issue or primary market, less than 6% of newly issued tax-free bonds carry bond insurance. Low volume of new issue supply has not been enough to replace insured bonds that matured. In the first half of 2019, $9.7 billion new issue tax-free bonds were insured. Conservative investors seek insured bonds to take shelter from credit risks and gain peace of mind. Insured bonds command high prices. Returns on a long term insured tax-free bond index have exceeded 11% this year.

Judge Slams Puerto Rico’s Spending Law…Upholding PROMESA requirements, Judge Swain rejected Puerto Rico administration’s move to dismiss a lawsuit which challenged higher government spending touted by the former governor. In defiance of the board certified fiscal plan, former Governor Rosselló enacted Law 29 in May 2019 to exempt Puerto Rico municipalities from funding pensions and have the Puerto Rico central government foot the bill. The populist law, which meant $1.7 billion of additional government spending through 2024, was frowned upon by the Island’s Oversight Board and its general obligation bondholders. The Oversight Board seeks to void Law 29 because it failed PROMESA certification requirements. Judge Swain stated that former Governor Rosselló “repeatedly, consciously and deliberately breached the PROMESA certification requirements” as she allowed the Oversight Board’s complaint to move forward. Government spending is at the core of Puerto Rico’s fiscal problems.

New Jersey Law A Boost For Local Government Cash Flow…A new law enacted by Governor Phil Murphy allows New Jersey local governments to pay certain larger non-residential property tax appeal refunds over an extended time. While New Jersey local governments hold reserves for tax appeals, tax appeals on commercial real estate could be unpredictable and large. Such was the case with Atlantic City a decade ago. With the new law, New Jersey local governments will have more time to address the appeal instead of the current 60 days. Tax appeals could be paid off over a three-year time-frame, new debt could be issued, or internal funds could be purposed to achieve an economical outcome. The credit positive law improves risk management and boosts liquidity for New Jersey local governments.

Connecticut Bonds Rally…CT bonds have returned 7.79% this year outpacing overall muni market index 7.4% return. The extra yield that investors demand to hold Connecticut’s general-obligation bonds maturing in 10 years has shrunk to 0.43 percentage points, the lowest since May 2015. Since the Great Recession, CT state revenues have rebounded 15.9% per Pew Charitable Trust. In Fiscal 2020 Connecticut expects a small surplus and will build its rainy day fund. So far, CT is on track to end the year with a $126 million surplus per state officials. This surplus projection does not include the impact of a potential settlement of hospital litigation. Connecticut projected it would have $2.9 billion in its rainy-day fund at the end of fiscal year 2020, enough to cover about 15% of its annual budget.

State Help, More Taxes Sought by Chicago Mayor… “We need to have help from Springfield to address the challenges that we have in the city,” Mayor Lightfoot added “Now some people say, “Well, we can’t do a Chicago bailout,” but the reality is, Chicago is 80% of the economy of this state. We are the driver of the economics in the upper Midwest.” The Mayor has also sent out an online survey asking Chicagoans which taxes they would increase to offset its expected budget hole. “It’s worse than that,” Mayor Lightfoot has disputed the Emanuel administration’s estimate of a $700 million budget gap. The Mayor’s “State of Chicago” address this week is much anticipated.

Weak U.S. Manufacturing Amid Global Cooling…For the first time during the record decade-long U.S. expansion, a bellwether purchasing managers’ index dropped below its neutral level signaling that U.S. manufacturing activity has slumped. Growth in new orders cooled to the weakest level in a decade, while new export sales dropped at the swiftest pace since the summer of 2009. An economist noted, “The PMIs for manufacturing and services remain much weaker than at the beginning of 2019 and collectively point to annualized GDP growth of around 1.5%.” The U.S. may not be immune to lingering economic uncertainty; Morgan Stanley estimates that a global recession could be within a year. Stressing headwinds from trade disputes, Fed Chair Jerome Powell noted, “We have seen further evidence of a global slowdown, notably in Germany and China.”

Compare 30-Year taxable U.S. Treasury yield 2.01% to 30-Year tax-exempt muni bond yield “AAA” 2.03%; “AA” 2.28%; “A” 2.40%; “BBB” 2.74%. For investors in the 35% tax-bracket, a 2.7% tax-exempt yield is equivalent to a 4.15% taxable yield. Top rated tax-free bonds yield 101% of comparable taxable U.S. Treasuries.