Week of 8/5/2019

Drop in Yields Fuel Muni Bondholder Gains… Long Term Tax-Free Bonds Continue to Outperform… Outlook on Illinois Credit is Now “Stable”… Chicago 2020 Budget Forecast Expected Shortly… Connecticut Peak Rainy Day Funds Forecast Could Break Record… New Puerto Rico Governor Pierluisi Must Gain Senate Confidence Amid Controversy…

Drop in Yields Fuel Muni Bondholder Gains…A big drop in yields occurred last week. Long term U.S Treasury yields dropped 28 basis points to 2.29% from 2.57%. The 10-year U.S. Treasury yield dropped to 1.76%, the lowest in more than five years. At the beginning of 2019, the bellwether 10-year U.S. Treasury yield was at 2.66% and 2.88% a year ago. The downward trajectory of bond yields has been driven by tariff concerns, persistently low inflation and slower economic growth. For the first time in a decade, the Federal Reserve cut interest rates by 25bps. The Fed is ending the runoff of the $3.8 trillion asset portfolio two months earlier than scheduled to ease monetary policy. U.S. tariffs on an additional $300 billion of Chinese imports could be potentially deflationary and stress retail and manufacturing jobs, despite solid July jobs growth. The Fed’s preferred measure of inflation, core prices, are now up 1.6% year over year, well below the Fed’s 2% target rate. “We’re trying to sustain the expansion,” Fed Chairman Jerome Powell called the July rate cut a mid-cycle adjustment. Recession fears are reflected in an inverted yield curve. Upending the norm of higher yields for longer term bonds, the benchmark 10-year U.S. Treasury yield is currently 30 basis points less than 3-month U.S. Treasury bills, which signals potential recession fears and further rate cuts. A majority of traders anticipate a September rate cut. Bond yields are set to drop further.

Long Term Tax-Free Bonds Continue to Outperform…Considering municipal bonds are federally tax-exempt, munis taxable equivalent yield is considerably more than that offered by comparable U.S. Treasuries. A long term top rated muni tax-free yield of 2.30% has a taxable equivalent yield of 3.54% for investors in the 35% tax bracket. A similar maturity taxable U.S. Treasury bond yield of 2.30% has an after tax yield of 1.50% for investors in the 35% tax bracket. Top rated tax-free munis, second in safety to U.S. Treasuries, are at the center of the bond rally that has accelerated since the Fed’s rate cut. Investors have poured funds into tax-free bonds for thirty weeks in a row as 2019 supply is trending lower than a year ago. Long term municipal bonds maturing in over 20 years have returned 8.44% to date this year.

Outlook on Illinois Credit is Now “Stable”…All three rating agencies have confirmed a change to a “stable” outlook for Illinois from “negative” earlier. “A big piece was the revenue surge that allowed them to make fiscal decisions that stabilized their credit profile,” a Fitch analyst noted this week. Fitch does not consider recent litigation from a hedge fund to be a material credit factor. Affirmations have come from Illinois Governor, Comptroller, Treasurer and Attorney General that Illinois General Obligation (GO) bonds fulfill all state constitutional requirements. Over the last three months, Illinois’ fiscal position has improved. Illinois’ political landscape has changed for the better this year. Although revenue outperformance in fiscal 2019 led Illinois to close a budget gap, long term liabilities of pensions and debt are well-above state median for the lowest-rated U.S. state. While upgrades may not be in the near future, downgrade risks have abated. “Illinois is already much stronger than we were a year ago, and it’s refreshing that Fitch is recognizing the good news and the progress we’ve made so far,” Deputy Governor Hynes stated. Illinois’ GO bonds have gained 7.38% this year outperforming muni market gains of 6.39%.

Chicago 2020 Budget Forecast Expected Shortly…A higher real estate transfer tax and a new tax on professional service transactions could be in the mix of new revenues, Mayor Lightfoot mulls ahead of a preliminary budget forecast expected by late August. Faced with a large operating deficit, Lightfoot and her team are putting in an extra month of budget prep to allow the city “to analyze year-end totals, program costs and other factors impacting the economy. The goal is to develop a well-informed forecast to guide our fiscal year 2020 budgetary decisions”. Like prior years, Mayor Lightfoot plans to meet investors in September to provide a status on the finances of Chicago and Chicago Public Schools.

Connecticut Peak Rainy Day Funds Forecast Could Break Record…Connecticut rainy day funds could peak at $2.3 billion for fiscal 2019 to eclipse record rainy day funds of $1.37 billion in 2009, CT administration forecasts. CT reserves could grow in the current fiscal year as well per its Office of Fiscal Analysis. If forecasts bear out and exceed thresholds, investors could see the wealthy outpost of the TriState area chip away at its pension debt.

New Puerto Rico Governor Pierluisi Must Gain Senate Confidence Amid Controversy…Newly sworn-in Governor Pedro Pierluisi will face the Island’s Senate for a hearing and a vote this week. Puerto Rico House of Representatives voted to confirm Pierluisi’s appointment last week. Pierluisi’s appointment, although timely, faces controversy. Senate President Thomas Rivera Schatz has interest in the top job and opposes Pierluisi’s appointment. Pierluisi has served as the Island’s Justice Secretary and was the Resident Commissioner when Congress enacted PROMESA. Pierluisi has been a legal counsel in a Washington D.C. law firm that advises the Oversight Board and is the brother-in-law of the Oversight Board chair, Jose Carrion. Ties with the U.S. Congress have earned Pierluisi the support of U.S. House of Representatives’ Democratic majority leader, Steny Hoyer, “The people of the Island deserve leaders they can trust. I think Pedro is someone who has earned his trust through years of service, including as a resident commissioner.” Pending Senate confirmation, the new Governor will not make any cabinet appointments. Minutes after the new governor was sworn in, Puerto Rico Justice Department informed that the Special Independent Prosecutor’s Panel would start an investigation on whether former Governor Rosselló’s infamous chats that led to his resignation constituted a crime. Pierluisi said, “Regarding any ongoing investigation, it needs to run its course” and “everything regarding corruption” needs to be handled. “There is no time to lose. The hard work to rebuild our Island after the onslaught of Hurricane Maria, improve the fiscal situation of our government, get our economy growing, and restore the credibility of Puerto Rico cannot stop,” Governor Pierluisi said one of his main priorities is “restoring the good name of Puerto Rico”. The Puerto Rico Senate filed a lawsuit seeking to block Governor Pierluisi from continuing as governor. Amid the controversy and confusion restructured Puerto Rico COFINA bond prices continue to move higher.

Compare 30-Year taxable U.S. Treasury yield 2.29% to 30-Year tax-exempt muni bond yield “AAA” 2.29%; “AA” 2.43%; “A” 2.62%; “BBB” 3.08%. For investors in the 35% tax bracket a 3% tax-exempt yield is equivalent to a 4.60% taxable yield.