Sharp Turns Ongoing in Municipals
We have a lot of uncertainties in the market that we are dealing with at present. The war in Ukraine, equity volatility, federal funding anticipated declines, the Fed and many more. Concerning the Fed we do have more clarity as of last week and we now know that multiple rate hikes are on the horizon. One certainty that has emerged is that the tone in the municipal market has changed appreciably. The losses in municipals on a YTD basis are somewhat hard to overcome.
One could argue that the recent experience of outflows from the mutual funds in the near term will change course before long. However, any evidence in support of this argument certainly is subject to question. Higher rates will serve to induce investors to maintain positions and to add new securities to their portfolios on a highly selective basis. There may be a slight shift to higher credit quality if not as much is sacrificed in terms of yield. The market does not have a particular concern with credit at present.
The consumer has become a sharp focus of the moment to assess economic activity going forward. With the ten-year Treasury around the 2.2% level, we learned last week that mortgage rates have climbed above the 4.0% level. Although the latter may be expected to put a damper on housing activity, the greater factor contributing to the pace is the level of inventory available to purchase. With housing prices up by approximately 25 % or more, the turnover must slow. Incomes have improved by not by the same increment. The resultant slowdown in turnover will lead to a moderation in assessed valuation growth that will have a noticeable impact on property tax receipts.
The other concern on the consumer front is the rising gas prices. Although the internet has taken a greater share of retail sales especially since the onset of the pandemic, people still get in their cars to go purchase necessary and discretionary items. Malls that were considered moribund within the last two years are seeing more traffic. Reducing the number of trips in the car should serve to moderate sales by a noticeable amount. In turn. States and localities will be keeping an eye on sales tax collections especially in states such as Texas and Florida that rely on this key revenue source for their general fund budgets. Most of the sales tax backed bonds outstanding have excess coverage about requirement but the sector may bear some monitoring. Interim information may be hard to come by, but some entities do post the levels to their websites.
Another idea that has surfaced once again is the consideration of gas tax relief. If a consumer was paying $40 to fill up and is now paying $50 or more the hit to the budget may be significant. This is especially true for regular commuters. Any relief of state and any local taxes would be expected to top out somewhere in the range of $20 per month or so with a lot of assumptions. Is this level of relief worth the effort? There is also the considerable administrative burden that no doubt would command a portion of the savings. In jurisdictions that have gas tax bonds outstanding, relief would equal some attenuation in debt service coverage. Given the amount of relief provided and the disruptive nature of the process, I would say this relief would not be worth the effort. There would be more efficient ways to provide some relief using other methods. Some have suggested relief on the federal gas tax but doing so would be most disruptive to all the infrastructure plans that have been judged essential.
Towards the end of the quarter and into the start of the next quarter, we usually see an uptick in new issue supply. I do not see the present course of rates changing the seasonal pattern all that much. Issuers may need to be convinced that issuing now makes good economic sense and that there is not a benefit to waiting or postponing. Secondary activity has picked up and the competitive market usually provides an objective read on the new rate environment.
As rates rise, one would expect some level of increased activity in variable rate bonds. The demise of LIBOR may also influence the variable rate market, but we would expect that the level of rates is a greater factor. Insurance may be expected to be a more sought-after feature in the rising rate environment.
I do not believe that there is more tax selling this season than normal. However, there may be more of a true up by investors at tax time because of the plethora of capital gains that have been realized before the turn of the year.
John Hallacy
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