Week of 8/29/2022

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Fed To “Keep At” Inflation Fight… Markets Reset Rate Hike Odds… July Inflation Eases… Puerto Rico’s Outperforming Tax Revenue Slows… Wayne County, Michigan Earns Upgrade…Big Money Ballot on Sports Wagers… Attractive Tax-Free Bond Yields…

Fed To “Keep At” Inflation Fight…“Restoring price stability will likely require maintaining a restrictive policy stance for some time,” Fed Chair Powell said at Jackson Hole that the Fed will continue with rate hikes. High rates could remain in place for longer than earlier thought. Powell added, “the historical record cautions strongly against premature loosening policy”. Powell explained “July’s increase in the target range was the second 75 basis point increase in as many meetings, and I said then that another unusually large increase could be appropriate at our next meeting. We are now about halfway through the intermeeting period. Our decision at the September meeting will depend on the totality of the incoming data and the evolving outlook. At some point, as the stance of monetary policy tightens further, it likely will become appropriate to slow the pace of increases.” Powell warned that there would “very likely be some softening of labor market conditions” and “some pain” for households and businesses” but the Fed “must keep at it until the job is done”.

Markets Reset Rate Hike Odds… Lower chances of rate cuts in 2023 and more monetary tightening this year are in the cards. Markets expect the Fed to raise interest rates to 3.8 per cent by February 2023, up from 3.3 per cent expected earlier this month. Roughly even odds of a half-point or three-quarter-point hike at the Fed’s September meeting are reflected by futures contracts. Atlanta Fed President said he thinks rates should go up by 100 to 125 basis points above current levels. “In terms of staying there, I think we should stay there for a long time.”

July Inflation Eases… The latest indication of cooling prices comes from July personal consumption expenditures price index (PCE Index), which fell 0.1% from a month earlier, the first negative print since the start of the pandemic. From a year ago, the PCE Index gauge was up 6.3%, down from a four-decade high of 6.8% in June. Fed-preferred core PCE index, which strips out volatile energy and food, are up 0.1% in a month, and 4.6% higher than a year ago, a slight deceleration from a 4.8% pace in June. Softer PCE Index reading echo easing of prices reflected in the consumer price index or CPI Index, a separate inflation gauge. Inflation is still well above the Fed’s 2% target. However, home prices have declined somewhat after 12.6% fewer single-family homes were sold in July. New home sales fell in July for the sixth time this year to the slowest pace since early 2016. Fed Chair Powell dismissed recent data showing a slight easing of inflation as insufficient, adding: “A single month’s improvement falls far short of what the committee will need to see before we are confident that inflation is moving down.”

Puerto Rico’s Outperforming Tax Revenue Slows… Puerto Rico’s general fund revenue for the fiscal year ended June 30, 2022 has outperformed oversight board projections, but recent data shows that the Island’s tax collections have lost some steam. In June-22, general fund tax collections were 2.9% lower compared to June 2021. Faced with high inflation, consumers appear to have pulled back from the heady spending seen last year. June sales and use tax collections is only $1.2 million more than last June. However, sales and use tax collections logged $2.6 billon in Fiscal 22, 20% higher than budget. Fiscal 22 general fund tax revenue $12.3 billion is 13% higher than January projections and 14.4% higher than prior year.

Wayne County, Michigan Earns Rating Upgrade… A two-notch Moody’s upgrade to ‘A1’ from ‘A3’ with a stable outlook for Wayne County, Michigan comes after a round of upgrades in 2021. In solidly investment grade territory, Wayne County, MI lost investment grade status in 2015 when it faced mounting deficits and pension woes. The county, home to Detroit, worked its way back to a solid investment grade territory after renegotiating contracts, reducing pension underfunding and improving cash, during a consent agreement with the State of Michigan. The latest upgrade “reflects the continued strengthening of operating reserves and liquidity, aided by the restructuring of retiree benefits and proactive management. Tax base growth is solid, creating some cushion against the state’s strict property tax caps that can result in revenue losses during time of tax base contraction.”

Big Money Ballot on Sports Wagers… A California sports betting ballot measure could gain distinction as the most expensive state ballot. Native American tribal governments and few others, who enjoy a monopoly on many casino games in California, have put up $360 million in a high stakes ballot measure related to the legalization of online sports betting. While smaller tribes are aligned with online gaming stalwarts such as DraftKings and FanDuel, many larger tribes seek in-person bets at tribal casinos and horse -tracks. Voters will decide in November, and challenges such as litigation cannot be ruled out. A federal judge upended a pact between the Seminole Tribe and State of Florida that legalized sports betting, resulting in suspension of sports betting in Florida. Sports betting has exploded in the United States after the Supreme Court allowed it to expand outside of Nevada four years ago. 30 U.S. states and the District of Columbia have legalized sports wagers. Americans wagered a record-setting $57 billion on sports in 2021 per the American Gaming Association. The most sports bets are placed in New Jersey, which overtook Nevada recently. California has the potential to become one of the largest sports betting markets worldwide.

Attractive Tax-Free Bond Yields… Top income tax bracket investors stand to receive notably higher tax- adjusted yields from state and local government bonds relative to United States Treasury bonds. Top-rated long-term tax-free municipal bonds yield 102% of taxable Treasuries. In the wake of the Fed’s latest rate hike signals, municipal bond yields remained mostly steady although global financial markets sold-off. The yield on the US two-year note climbed as much as eight basis points to 3.48%, while 10-year Treasury bond yield increased by a similar amount to 3.13%. Generally, the municipal bond market views Federal Reserve’s aggressive rate hikes as a way to lower inflation expectations.

Compare 30-Year taxable U.S. Treasury yield 3.23% to 30-Year tax-exempt muni bond yield “AAA” 3.29%; “AA” 3.76%; “A” 4.09%; “BBB” 4.14%. For investors in the 35% tax-bracket, a 4.14% tax- exempt yield is equivalent to a 6.37% taxable yield. Top rated long-term tax-free bonds yield 102% of comparable taxable U.S. Treasuries.