Trimming trees and budgets
This time of year, we turn to experiencing good cheer and for some of us trimming trees. Yet, the holiday spirit is not enough to mask the underlying seriousness of cutting the federal budget according to principles espoused by the DOGE committee. Much is at stake. But I have been saying for some time that the federal deficit and the debt need to be addressed head on before they become real problems. GDP is growing but is not growing fast enough to minimize the impact of these two critical factors.
The primary target of the budget cutters as far as we know is concentrated on the discretionary slice of the budget that is the smallest part of the total budget. However, there is talk that Medicaid spending will come under particular scrutiny. Since the program is jointly managed with the states, there is the potential for major implications for state budgets. Medicaid spending is either the first or second priority for states vying with education spending. Even a more minor cut of 5% to 10% would have major implications and would be exceedingly difficult to offset or “backfill”. We must not be overly speculative here, but we must brace ourselves for what is to follow.
Another aspect of the trimming is that federal employees are spread across all fifty states. One potential target that has been identified is the Veterans Administration. Every state has employees on the ground for this important service.
Public service employees pay income taxes where they are in effect and many other taxes in their home state jurisdictions. The federal government employs approximately 2.04 million people without counting the military. A reduction of 10% or more could have relatively large impacts on state revenues and the safety net spending on unemployment benefits. In the past when unemployment benefit spending has climbed appreciably and a state needed to borrow from the federal government to pay benefits that borrowing was done at a taxable rate. There were some municipal transactions done to refinance that debt. Although, at present, we are quite far from such a scenario. The latest reading on Unemployment at 4.2% is not particularly worrisome.
Other programs will be reviewed in detail. I have some optimism that transportation will fare better than other categories. However, I emphasize once again that Republicans are not great supporters of mass transit.
We will keep monitoring these targeted developments as they unfold.
Turning to the municipal market, the volume is near to obtaining an all-time high of $500 billion in issuance. The prognosticators for next year are signaling volume should be as high and one outlier has indicated issuance could be as high as over $700 billion. If the federal government cuts back on state and local grants, this number may not be as far-fetched as it sounds.
We are now anticipating the Fed’s next move on rates in mid-December. Consensus has built around another 25-basis point cut as expected. However, the future is becoming murkier. The emphasis of the administration-elect on a strong dollar and on tariffs will make it more difficult for the Fed to reach the 2% inflation target. If inflation remains a good margin above the 2% target there is every reason to believe that the pace of rate cuts will be slowed.
Extending the tax cuts will be central to many of the debates in Congress next year. At this point, we must assume that the extension will take place. How the revenue hit will be offset will be crucial. We do not know if those formulating the federal budget will look to municipals as a potential additional source of revenue just yet. But we must be alert to the possibility.
In the meantime, the positive inflows to the funds and ETFs are keeping the market tone quite positive.
May the holiday spirit prevail.
John Hallacy
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