Muni Bond Update: Credit Quality Still Looks Strong

Andrii Dodonov

By Jennifer Johnston, Director of Municipal Bond Research, Franklin Templeton Fixed Income

While 2023 has started connected shaky crushed for nan municipal enslaved market, location are reasons to beryllium optimistic for much stableness ahead, according to Jennifer Johnston, Franklin Templeton Fixed Income’s Director of Municipal Bond Research. She explains why California’s issues don’t bespeak each states, and offers reasons for optimism.

Check retired nan video beneath featuring Jennifer and Jack Mcgee, elder merchandise manager, Franklin Templeton Fixed Income, to perceive much thoughts connected muni bonds, including sectors to watch.

As we bespeak connected nan disappointing capacity of municipal bonds successful 2022 and moreover truthful acold successful 2023, nan fundamentals really person not been a driving force. In fact, successful galore cases, we person really seen a highest successful position of muni enslaved in installments quality, and galore municipalities are really stronger coming than they were anterior to COVID-19. Hopefully, authorities and section governments person prepared themselves for nan adjacent rainy day.

Coming into 2023, municipal enslaved fundamentals were beardown arsenic astir authorities and section issuers utilized COVID-19 alleviation costs to reside pandemic costs and economical challenges truthful they statement up rainy time costs and position themselves for a imaginable economical slowdown. States successful peculiar entered nan twelvemonth pinch very beardown equilibrium sheets that surpassed levels seen earlier nan pandemic.

California an outlier, not an example

Following a immense surplus successful nan anterior fiscal year, California now projects a ample projected shortage successful California for fiscal 2024. California’s fund shortage has gotten a batch of media attraction fixed nan state’s sheer size. But nan shortage was not a astonishment to america arsenic we person been monitoring nan authorities monthly and we deliberation it’s an outlier for a fewer reasons. However, we consciousness this volatility is not a inclination we spot nationwide. California is highly reliant connected income taxes arsenic a main gross source. California’s income taxation building is very progressive and arsenic a consequence it has a precocious reliance connected superior gains taxes, which were muted during past year’s wide marketplace downturn. We still consciousness California tin utilize its reserve costs (which are nan highest successful its history) and different fund measures to sphere its fiscal spot complete this coming year. We deliberation California tin upwind this year’s challenges.

In contrast, astir different states are reporting higher-than-expected income and income taxation receipts. Illinois, for example, is simply a stronger in installments than earlier nan pandemic. The authorities is projecting an further US$1.2 cardinal successful gross since nan past projection successful November. The authorities has utilized its surpluses smartly and has prepaid pension expenses and debt. It really has seen a turnaround.

The effect of ostentation

Inflation not only hits consumers, it hits governments too. Wage ostentation has created challenges, but it besides increases income taxes, truthful that tin really person a affirmative effect for states. Sales taxes besides summation arsenic nan value of equipment increase, and we’ve seen bully capacity successful income taxes. To combat inflation, liking rates are rising, however, truthful nan costs of borrowing for governments is going up.

The bully news is that rainy time costs are adjacent all-time highs arsenic states utilized national support costs to salary down indebtedness and trim expenses. So successful sum, higher inflation, costs increases, and further borrowing costs are having a antagonistic effect connected budgets, but these are being partially offset pinch higher taxation gross from further economical activity.

Last twelvemonth saw galore standing upgrades crossed respective states, reflecting their beardown financial positions. We proceed to measure issuers individually, but arsenic a whole, we consciousness municipal enslaved fundamentals will stay supportive of nan assemblage passim 2023. We expect that states person nan devices to negociate nan challenging environment. As investors, we deliberation location is ever opportunity—and that is still nan lawsuit today.

What are nan risks?

All investments impact risks, including imaginable nonaccomplishment of principal. The worth of investments tin spell down arsenic good arsenic up, and investors whitethorn not get backmost nan afloat magnitude invested. Because municipal bonds are delicate to liking complaint movements, a municipal enslaved portfolio’s output and worth will up and down pinch marketplace conditions. Bond prices mostly move successful nan other guidance of liking rates. Thus, arsenic prices of bonds successful an finance portfolio set to a emergence successful liking rates, nan portfolio’s worth whitethorn decline. Changes successful nan in installments standing of a bond, aliases successful nan in installments standing aliases financial spot of a bond’s issuer, insurer aliases guarantor, whitethorn impact nan bond’s value.

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Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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