Many Americans want a robust round of Congressional aid to support the economy through the COVID-19 vaccine roll-out.
The Biden administration wants to downstream $350 billion directly to state and local governments to address reduced tax collections and other pandemic-related damage, with additional support for public transportation, healthcare and education.
No fiscal relief package can offset all the economic loss in every state but all federal aid should be viewed as a positive for the municipal market.
The downside for municipal bonds, which have priced in high expectations for future federal support, is that Washington policy often moves slower than headlines suggest. Political uncertainty will elevate bond price volatility for those debt issuers more dependent on fiscal support. Still, the broader municipal market will benefit from support planned to go to education, transportation, and healthcare sectors.
At the earliest stages of the pandemic, third-party estimates of fiscal 2021 state revenue shortfalls ranged from $130 billion to $200 billion — more than double the impact of the Great Recession. Thankfully, most shortfall estimates were too aggressive.
The third quarter 2020 Census State Revenue Report highlights a $37 billion decrease, just -4.4%, in total year-to-date state tax collections. Better-than-expected revenue collections translate to improved municipal government budgets — and to fundamental strength supporting bonds.
Texas recently announced its current-year deficit declined to nearly $1 billion, which is a fraction of the original $4.6 billion shortfall estimate.
California is projecting a fiscal 2021 $26 billion surplus. That is a stark difference from the state’s early $50-plus billion deficit projection in the spring of 2020.
Large capital gains resulting from historic U.S. stock market performance during the pandemic helped swing revenue collections. However, states are not equally impacted by the pandemic.
Alaska, Connecticut, Hawaii and North Dakota reported the largest year-over-year tax collection falloffs, from -19% to -26%. This underscores the need for investors to appreciate the complexity of public finance credits within their portfolios.
While smaller than originally projected, state revenue shortfalls must be overcome in the short term, and this challenge is now paired with a wounded U.S. labor market likely to remain scarred for longer than some expect.
These budget hurdles will force some states to adopt austerity measures, the level of which will be ultimately informed by the pandemic’s length and by potential federal stimulus measures. The broad muni market should be spared significant cuts from underlying budget flexibility. It also can benefit from future federal fiscal support.
Given the current economic and political backdrop, rescue packages are sure to come before meaningful tax reforms. But down the road, individual and corporate taxes will rise. We believe those changes, too, will be positive for municipal fundamentals and future demand for tax-exempt bonds.
We also believe investors will be well served by taking a longer view — focusing on credits that should perform well in an economy with fewer COVID cases — with the understanding we will confront difficulties while getting there. Some of the best values in the muni market are within sectors that can benefit from a successful COVID vaccine roll-out, including transportation, higher education, and healthcare issuers, and very selectively some issuers that rely on travel, entertainment or hospitality.
Municipal bonds have rebounded strongly from the massive dislocation seen throughout the global markets last year, thanks largely to Congressional stimulus and effective U.S. Federal Reserve moves.
While valuations are less attractive today than they were last year, there are few alternative low-risk assets able to produce the tax-exempt income that so many American investors seek.
