Turbid Waters
Perhaps you are out on the water and cannot see the bottom clearly. It feels like we are encountering similar circumstances when considering the market. The bottom of the market is opaque, and we have a keen need to stay invested simultaneously. Equities were performing better for the last few weeks and are now on a negative path again.
Much has been made of the backing off of the short end in municipals. Empirical experience tells me that this too shall not last. Corporations buy municipals especially on the shorter end when municipals are cheap and there are not as many good alternatives. If the short end continues to cheapen, buyers will be attracted back to municipals.
The retail bid has been fluctuating all year. The big rollover is now done, and we will need to rely on pure demand for a time. The municipal inversion is not causing buyers to eschew from investing in municipals. Macro factors are having a greater influence now.
All parties will be parsing all the verbiage that comes out of the Jackson Hole meeting later this week. The hawkish meter is on high alert. We know that the Fed is focused on forcing inflation down. Then why are we so eager to hear that they may have to change course next year? Hope is ever present, but it is not a strategy. It will be some time before the direction on rates actually does a reversal.
On a more positive not, the Inflation Reduction Act has passed and there are great expectations that the provisions will provide some real change for climate improvements, power generation changes, and EV purchases among the many provisions. Municipals will be called upon to fill part of the funding gaps that are not provided by the federal provisions on many projects. Charging stations for EVs in certain circumstances may fit the public benefit definition but not in all cases.
Many of the provisions included in the Inflation Reduction Act will take some time to be realized. We have learned this aspect from the spending patterns under the American Recovery Act and the Infrastructure Act. But the difference for the former is that credits are a main feature, and the latter has been guided by cash disbursements.
The minimum tax and buy back tax provisions may not affect municipals indirectly but not so directly. Once again, if there is more of an effect on corporations, demand would change for municipals on the short end and on the taxable municipal side. At first reading, we do not see much of a change for Property & Casualty insurers or on Life insurers that tend to buy the intermediate and long end of the curve respectively.
The federal budget imbalance is reported to improving month to month due to greater tax receipts. Is this an economy that is slowing? If Treasury issuance continues to slow appreciably, we may expect some change in the municipal to Treasury ratios. Although we have had some high issuance weeks in municipals, we remain on target to come in lighter on the year in volume.
Returning to the macro themes, retail sales have been performing better than anticipated. The performance has varied among the specific retailers but overall has been strong. States that rely on the sales tax including Florida, Texas and Washington would be expected to have higher receipts.
We have not had a high-profile credit event in municipals in some time. High yield always has some problem credits but even in that segment of the market the troubles have been relatively light.
The recent highlight that schools do not have enough teachers for the Fall represents some challenges. In addition to some more remuneration for teachers, some districts may have to consider more seriously providing for housing for teachers in select markets where housing is dear. At this point, we may expect some added pressure on school budgets but there would not be enough financial impact to have a reconsideration of ratings in effect.
John Hallacy
John Hallacy Consulting LLC
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