Week of 9/27/2021

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Federal Aid Plugs Chicago Budget Gap… Federal Reserve Weighs on Economy, Policy… Odds Favor Powell Second-Term… Connecticut Boosts Pension Funding… Pension Obligation Muni Bonds Set Record… Pensions Cut Risks, Credit Positive… Governments Brace For Climate Risks…

Federal Aid Plugs Chicago Budget Gap… Mayor Lori Lightfoot unveiled a $16.7 billion spending plan that relies on federal money to help fill Chicago’s $733 million Fiscal 2022 budget shortfall. For the first time, Chicago’s plan for using nearly $2 billion federal direct aid became available. Most federal aid will go toward $1.3 billion revenue replacement over the next three years: $782 million in 2021, $385 million in 2022 and $152 million in 2023. The mayor’s third spending package includes modest property tax increases. Lightfoot will boost the property tax levy modestly by $76.5 million, a third of which comes from new development and the expiration of tax-increment financing districts. The Civic Foundation, a fiscal watchdog, noted that Lightfoot is, “avoiding very tough decisions that would otherwise have to be made”, by using federal money that won’t be there as a crutch in future years. Chicago’s structural deficit will also continue to grow in 2022 because of state imposed requirements for the city to increase funding for its pension funds. The city’s pension expenses will spike from $1.8 billion to $2.3 billion. Chicago could find an “enormous benefit” from the return of tax-exempt advance refunding’s, recently approved by the House Ways and Means Committee. Chicago has about $900 million bonds callable around 2024-25; by issuing tax-exempt advance refunding bonds instead of taxable ones, the city could realize up to $200 million in debt service savings. After last year’s pandemic budget passed with a narrow margin, federal aid has eased prospects for the Fiscal 2022 budget plan. Chicago CFO stated “There is still work for us to do,” as Mayor Lightfoot expects the city to reach structural balance by 2023.

Federal Reserve Weighs on Economy, Policy… The Fed held its current target rate near zero. It stated “if progress continues broadly as expected, the Committee judges that a moderation in the pace of asset purchases may soon be warranted.” Fed Chair Powell said financial conditions would remain accommodative even after the Fed stops its asset purchases, that many interpret could be in November. The Fed did not offer a specific date or time table. The Fed emphasized that the decision on the bond buying program was separate from any actions regarding interest rates. The Fed is evenly split between raising rates for the first time in 2022 or 2023. Benchmark rate hikes are expected to proceed slowly. The median projection for the Fed’s benchmark overnight lending rate is 1% in 2023 and 1.75% in 2024, still accommodative and easy monetary policy. The Fed views inflationary pressures to be transitory. When asked about the debt ceiling, Powell said its very important for it to be raised. A new round of COVID-19 concerns has led the Federal Reserve to downgrade economic growth expectations this year to 5.9% down from 7% projected earlier. Powell added, “No one knows with any certainty where the economy will be a year or more from now.”

Odds Favor Powell Second-Term… Odds favor Fed Chair Powell’s second four-year stint at the Fed’s helm. Some new Fed appointments may be in store. Powell has a 84% chance of a second term, while Fed Governor Lael Brainard faces 15% odds for another term per Predictit polls. Powell’s focus on jobs has won praise from the Biden administration and endorsements from Republican lawmakers. Progressive Democrats want the Fed to take on a more expansive role in the economy, while others want the Fed to stick to monetary policy. The Biden administration is actively discussing a decision about the next Fed chair. President Trump nominated Powell and a decision may come before the Fed’s November meeting.

Connecticut Boosts Pension Funding… Connecticut plans to transfer about $1.6 billion in excess budget reserves to its underfunded public pensions. A windfall of capital gains taxes from a surging stock market boosted Connecticut’s general fund reserve to 23% of general fund spending. State law caps budget reserve at 15% of general fund spending, with excess transferred to pensions. A drop in the bucket, given Connecticut’s $40 billion unfunded public pension liabilities, the boost in pension funding is a step forward.

Pension Obligation Muni Bonds Set Record… A record number of states and local governments are issuing bonds to fund surging pension contributions. This year, seventy-four issuers have sold over $10 billion of municipal bonds to finance pension costs, the most in two decades. Nationwide, municipalities face a pension shortfall of $4.5 trillion per the Federal Reserve’s latest analysis.  Years of underfunding and aggressive assumptions for investment returns contributed to funding shortfalls. One in three public sector workers is over age 55. A wave of retirements are looming large on state and local government pension funds. Pension obligation bonds, generally taxable, allow governments to avoid a budget crunch by funding pension contributions with debt.

Pensions Cut Risks, Credit Positive… Amid a low interest rate environment, the nation’s third largest public pension, New York State and Local Retirement System, moved to cut its investment return target by 1%. With its prior 6.8% return target, New York’s public pension fund faced a 60% chance of underperforming its target. State budget risks grow when investment returns fall below assumptions. The new 5.8% return target balances out budget risks evenly; there is a 54% chance that New York public pension assets outperform target investment returns. Record setting investment return in Fiscal 2021 significantly boosted assets for many public pension funds and improved funded status. Nationwide, most public pensions assume a 7% investment return, with some target as high as 8%; a few are opting to lower return targets in sync with the low yield environment to cut budget risks.

Governments Brace For Climate Risks… “We can’t outrun or hide from climate change,” Governor Pritzker stated upon sweeping energy policy overhaul signed recently that sets Illinois on the path to 100% carbon free power. New York Governor Kathy Hochul will fight for the Green Jobs, Clean Air and Water Environmental Bond Act of 2022, to expand funding for new environmental infrastructure programs in the Empire State. In California, Governor Newsom signed a $15 billion funding package for water quality, drought resilience, wildfire prevention and forest health. Hurricane Ida could cost the New York City’s subway system about $100 million. After Superstorm Sandy flooded large sections of the transit system in 2012, the MTA established a Climate Adaptation Task Force and implemented a federally funded $7.6 billion storm recovery and climate resilience program, as well as higher construction and design standards. In 2012, New York City initiated a $20 billion plan for storm resilience projects to mitigate weather risks to water, sewer, transit and commuter rail systems. Only 41% of Sandy inspired capital upgrades were complete in 2020. The federal government’s $14.5 billion investment in a levee and storm protection system in New Orleans seems to have paid off. Property damage from Ida, a Category 4 storm, will likely be less than a lesser Category 3 Hurricane Katrina, which remains the costliest hurricane in history. Governments have begun to reckon with the force of bad weather, a work-in-progress.

Compare 30-Year taxable U.S. Treasury yield 1.99% to 30-Year tax-exempt muni bond yield “AAA” 1.60%; “AA” 1.87%; “A” 2.05%; “BBB” 2.27%. For investors in the 35% tax-bracket, a 2.2% tax-exempt yield is equivalent to a 3.3% taxable yield. Top rated tax-free bonds yield 80% of comparable taxable U.S. Treasuries.