We take a ramble through municipal bond volume and trading activity, caution readers about year-over-year (YOY) comparisons, discuss the consequences of COVID migration patterns in the context of static population growth, raise potential credit concerns and comment on the unnecessary threat of US debt default.
Volume
We came pretty close to our forecast in 2022, that municipal volume would end about $100 billion lower than 2021. Several rate hikes from the Federal Reserve virtually wiped out refunding bonds and made new borrowings subject to greater deliberation. Recall that collapsed taxable yields in both municipal and treasury securities over the last three years made refunding tax exempt with taxable bonds sensible. Not anymore.
At times of rate volatility like these, secondary trading volume perks up as investors reposition their portfolios. Bloomberg author Shruti Singh pointed out that municipal trading was “sky high” last year; 50% higher than 2021 and highest since 2008. We think this will likely calm down in 2023 as the Federal Reserve completes its move off the “zero bound” of interest rates. The question now is when and where geographically, and for whom, recessionary impacts will be felt and whether these will be mild (“soft landing”) or deep (“hard landing”). We expect volume to continue at the pace where 2022 left off. That is, similar new issue volume, low refundings but less secondary market trading as portfolio managers have already mostly accounted for rising rates.
Beware of YOY Comparisons
Forecasting has become more difficult when factoring in COVID “re-opening”, which reversed activity away from buying goods to consuming services. Low mortgage rates and COVID fears propelled migration away from denser urban areas (more below) but home offices are stocked with requisite electronics and furniture as well as new home appliances and furnishings. It is no surprise that layoffs are taking place in tech and financial services. Plus, the persistence of supply chain bottlenecks, which came first from unanticipated demand for goods over services, coupled with a protracted COVID lockdown in China. As these conditions eased, Russia’s invasion of Ukraine turned energy and agriculture markets upside down. These factors have contributed to inflation and the Federal Reserve is busy tamping down demand to bring inflation under control. Pain is not uniformly distributed, however. For example, those that invested in traditional fossil fuels have made out well while those on tight budgets may be making “heat or eat” decisions this winter.
The Great Geographic Shuffle (and its consequences)
Domestic migration during the peak pandemic months “reveal an absolute decline in the aggregate size” of the nation’s major metropolitan areas while smaller and rural metro areas experienced high population growth. This, according to analysis by William H. Frey of the Brookings Institution. On top of the smallest growth in population in the U.S.in 120 years and absence of a reasonable immigration policy, economic growth must come from within US borders (“..over two-thirds of US counties registered a natural decrease in population” writes Frey). Brian Moynihan, CEO of Bank of America, mentioned in an interview with Bloomberg at the World Economic Forum in Davos, last week: “We need more people” (and he repeated that several times in the interview.) Ron O’Hanley, head of State Street, a global index fund manager, echoed similar sentiments in a recent Financial Times interview: “The uninterrupted pipeline of talent that was coming in has now been effectively stopped.” It makes good (rather, imperative) economic sense to level-up the wealth-building power of those that have been overlooked and underserved.
COVID migration patterns, stagnant population growth, supply chain shortages influence activity and pricing in the housing market. Bill McBride of Calculated Risk (paywall possible) noted that December housing starts were 1.4% below revised November figures and nearly 22% below December 2021 (seasonally adjusted, and for privately-owned housing). Building permits too, were 1.6% below November (seasonally adjusted) and nearly 30% below December 2021.
On the other hand, multi-family construction is higher than any year since 1973. Construction delays (and likely supply chain factors) are possible explanations. McBride points out that multifamily “starts” outweigh “completions” at this point, but should catch up soon. As this construction is completed, rental costs might ease. McBride concludes “a large number of housing units will be delivered in 2023.” Completions will likely offset the slowdown in permits and starts through 2023 and into 2024.
Citing Rick Palacios Jr., McBride commented that 26% of homebuilders cut prices more than 11% since March 2022. On a regional basis, Northern California had the highest level of reductions: 21% of home builders there had price cuts of 20% or more. In the Southwest and Northwest, price reductions between 11-20% were 44% and 37% respectively. Price reductions on new construction will, over time, layer into completed properties, bringing down the aggregate (Palacios is Director of Research at John Burns Real Estate Consulting, a “must follow for housing” on Twitter according to McBride.)
Credit Issues
Economic contraction will likely expose credit issues. A Black Knight Inc. report from the end of December (also sourced from Calculated Risk) indicated that November delinquency rates had risen to just over 3%, trending higher from prior months; and the delinquency rate in Florida rose to 3.6%. This was likely due to Hurricane Ian losses keeping affected homeowners from making mortgage payments. While foreclosures start climbing, they remain lower than pre-pandemic. States with the highest rate of 90+ days delinquency included Mississippi, Louisiana, Alabama, Arkansas, Oklahoma.
COVID out-migration may be a tipping point for some cities already suffering decades of decline. This is a pension and retiree healthcare problem for places that no longer have the businesses and population to support legacy obligations. We have cited this issue in past commentary about Puerto Rico, Detroit and more recently Chester, Pennsylvania. (For detail on Chester, see Liz Farmer’s three-part series at Route Fifty, here.) Resolution must come either from significant retiree benefit cuts, or external help from other levels of government since public pensions do not have a backstop such as the Public Benefit Guaranty Corporation, PBGC, for bankrupt corporations.
Along with rising mortgage delinquencies are the issues of eviction and homelessness (or in current parlance the “unhoused”). Eviction moratoria were in place at the federal, state and local levels during the pandemic and were extended several times in different places. In August, 2021 however, the Supreme Court struck down the CDC’s COVID eviction moratorium, which led to an increase in eviction filings. Nevertheless, filings remained “well below historical averages” according to the Eviction Lab at Princeton University. Authors of the Lab’s report also stated: “We estimate that nationwide at least 1.36 million eviction cases were prevented in 2021.”
Despite the offsets of stimulus and moratoria, homelessness is still high in the most expensive cities. The District of Columbia has twice the level of homelessness than the next highest city, New York, followed-by Hawaii, California and Oregon. These encampments impose costs on city budgets, and we wonder when or whether residents will be able to return to health and productive employment after the trauma of eviction and life in a tent city for some time.
Elsewhere, numerous states have used money from the American Rescue Plan Act (ARPA) to pay for tax cuts, which could have fiscal consequences down the road. Much of the discussion has focused on whether states have a right to do so under the Act. Thirteen states challenged the US Treasury on this point, and on January 20, the Eleventh Circuit ruled in favor of the states. (West Virginia, Alabama, Arkansas, Alaska, Florida, Iowa, Kansas, Montana, New Hampshire, Oklahoma, South Carolina, South Dakota and Utah.) But what happens to these states’ fiscal condition when ARPA monies run out?
The Debt Ceiling Vote and Spending Cuts
While certain members of Congress are wailing about surpluses in state and local government coffers, we believe these funds will get mopped up over the next year as recession takes hold. Keep in mind that inflation also eats away spending power for state and local governments. (Nominal revenues are up and this is mostly what gets reflected in headlines. Major government taxes are levied ad valorem, or on the value of property assets, price of items purchased, and income bracket, which visibly grow during inflationary times.)
There could be further symbolic (shambolic?) votes in the House to rescind appropriations, (such as the vote on party lines to take away $7.6 billion of IRS appropriations on January 9th – see here as well) but these will have to get past the Senate and the President, which are unlikely. Various spending cut proposals will emerge in the next few months, causing rolling consternation among affected groups. We recall similar debates in 2011 from the Tea Party, which resulted in a US rating downgrade and passage of the “Budget Control Act of 2011”, BCA. BCA included the much unloved “sequestration” that clawed back money when spending caps were exceeded.
The BCA had limited staying power over time. When a particular cut offended a critical voting block, Congress reversed BCA limitations, including suspending the debt limit altogether from 2019-2021. We expect similar behavior to continue in 2023 accompanied by market volatility and uncertainty. Rather than extend your reading time, for those interested in more detail about the BCA, see here, here, here and here for starters.
Finally, the “My Way or the Highway” hyper-partisan approach to governing is alive at the state level as well as federal. Pew Trusts pointed out last week that only 10 states now have shared power in the statehouse; the lowest since 1952. Republicans have a “trifecta” in 23 states while Democrats control the governor’s office and legislature in 17. The article suggests that with high profile issues like abortion and guns a state may approve legislation that conflicts with the viewpoints of a majority of voters. Pew’s Stateline Executive Editor, Scott Greenberger wrote: “…complete control by one party can empower its most extreme members, who might care more about posturing…than enacting policies designed to benefit the greatest number of people.” Case in point is the recent “gas stoves” controversy. Florida Governor DeSantis tweeted “Don’t tread on Florida, and don’t mess with gas stoves” and he also brought this up at a rally. Ironically, only 8% of Florida households use gas stoves according to the Energy Information Administration – the lowest in the nation. Is the governor suggesting that 92% of constituents that cook their food on an electric stove pay to have gas lines installed to make a point?
Headlines will certainly be disruptive to markets from day to day and we expect lots of obstructionism, some real and some just posturing. As we get closer to the end of “extraordinary measures” designed to postpone a debt ceiling crisis and again as we get closer to the next presidential election, markets will remain volatile. Many economists believe there will be a government shutdown this summer (which is different than not paying on our debts). On the positive side, we note that the Committee for Responsible Federal Budget, CRFB, found that the Inflation Reduction Act, IRA, would reduce inflation (despite the view of many, that the Act, does not do so.). All that said, and despite the negatives, the sum of these trends has us leaning towards “soft landing”.
