Of all of the markets in all of the world, it had to step into mine. The r-word or recession is back with a vengeance. The talk was so hyper on the yield curve inversion and the equity downdraft that one would think a recession event would be happening tomorrow. However, despite the appearances of the negative indicators, we have some distance before any actual event. Employment is up, unemployment remains low, and mortgage rates all of a sudden have become quite favorable. Why worry?
The trade situation takes me back to my days of study of Smoot-Hawley tariffs of an earlier era. Those tariffs approached 50%. My professors at the time did their utter best to impress upon me that tariffs are generally a bad idea when it comes to the economy.
What tariffs ultimately do is contribute to a lower level of trading, and consequently growth. Growth is the lifeblood of any economy and it so happens that forecasting the growth rate accurately is critical to formulating state and local budgets. Forecasting load growth accurately in the power sector is also critical to all aspects of generation and transmission forecasting. I could go sector by sector but you get the point.
If there is an abundance of volatility in the critical indicators that are the linchpin of state and local budgets, the task of budgeting becomes that much harder to accomplish. Revenue forecasters at the state and local level are often the unsung heroes of the budget realm. I have always greatly appreciated what expertise it takes to be accurate to within 1% to 2% of a forecast on actual results. This outcome requires real knowledge of the inputs and a real sense of what have been the critical factors over time.
All of this discussion leads me back to where we are at present. When everyone returns after the summer holidays, the real budgeting work begins once again. We have been fortunate enough to have experienced 3%-plus growth in the recent past. Now the IMF and others have put growth in the range of 1.8%. The tariff circumstances have the real possibility of affecting this forecast. It was a wise move to delay the implementation of some of the tariffs until mid-December to save the holiday shopping season. It is true that the sales tax receipts for most governmental entities are greatly influenced by the activity during this critical period. Cash-flow-wise, the real effect is not realized until the first quarter. Getting these numbers in the appropriate range is important to the financial performance and results of states and localities.
Which brings me back to the fact that most market participants have shared increasing concern about how long this expansion will persist and when will we be facing the harsh turn in the economy. The old rubric is that expansions do not die of their own accord but the change is triggered by some event. Will tariffs be the catalyst this time around? The possibility exists.The global economies are so much more integrated than they have been in past recessions that any event that is likely to unfold will do so differently this time. Thus, the forecaster's job is ever more challenging.
The backdrop for a cautious approach on budgeting is that municipal credit is quite strong these days with some exceptions. Fund balances have been rebuilt and there has been discussion about putting more of the funds aside in Rainy Day Funds in anticipation of the turn. At the same time, all spending priorities are receiving some attention in this environment.
Current conditions in the municipal market are relatively ideal from an issuer perspective. Rates are at historic lows, inflows to the mutual funds have maintained strength week after week, and ratings have been stable to improving. Supply has been somewhat soft and below the estimates at the start of the year that translates into enhanced receptivity for issuer paper. Many deals have been oversubscribed. What is not to praise?
From an investor’s perspective, yields leave something to desire. Some developments do cause some consternation. Cybersecurity is a prominent issue. Stopping hackers from taking systems hostage for bitcoin is a daunting task. Software needs to keep evolving to prevent this near term threat. In the longer term, climate change is demanding more staff time and planning to address. Many worthy projects that merit funding and bonding for proceeds will be shelved if a recession hits. It is best to get started with these projects now.
We hope for positive developments on the tariff front to bolster future growth and to contribute to the resiliency of budgets in the municipal market. Issuers and Investors will be appreciative. Municipal professionals would also benefit and would be less beholden to the dark forces in the economic future. We cannot control all of the other factors. We just have to work within the constraints of the macro status.
