Market Outlook

“The overall message is accommodation.” This was the latest policy clarification from Fed Chairman Ben Bernanke, a day after the release of the minutes of the FOMC meeting showed deep dissension within the Fed’s ranks as to the timing of monetary stimulus removal. The other part of the message? “Tapering” is not the same as “tightening;” even if the Fed started to reduce its asset purchase program this year, it will still be quite a while before economic growth is sustainable enough to force an increase in short-term rates.

This time around, the markets liked what they heard. A surprise rise in jobless claims this week underscored the still-fragile nature of the US economic recovery, thus lending some credence to the Chairman’s latest posturing. Global equity markets from Europe to Asia rallied sharply on the news. In the US, the S&P 500 is now on track to erase much of the loss it has incurred over the last two months.

Treasury yields, which may have already discounted the worst case scenario based on current economic data, also staged a modest rally: 10-year and 30-year Treasury yields closed on Thursday at 2.57% and 3.62%, respectively.

Munis Firm Up

On the muni side, this week’s new issue slate (including two airport revenue offerings from Denver and Dallas Fort Worth) got a reasonable reception from investors, as underwriters decided not to take any chance and priced everything quite attractively. The successful placement of the new deals gave traders some basis for price discovery and this, in turn, allowed the tax-exempt benchmark scale to firm up by about four to five basis points for longer maturities on Thursday.

The investor exodus from the mutual funds is not quite over yet. According to Lipper, outflows for weekly reporting funds rose to $1.2 billion for the week ending June 10th. In a disappointing turn of events, high yield muni funds, which did experience modest inflows last week, saw outflows resume this week to the tune of $207 million. Overall, this marked the seventh straight week of outflows from the weekly reporting muni funds.

For now, as we discussed in earlier articles, the funds’ loss could be the retail investor’s gain, as individual investors and Separately-Managed Account (SMA) managers have been able to pick up cheap bonds from the funds’ forced liquidations. (John Bagley from online trading platform BondDesk wrote an entertaining account of how retail investors have stepped into the breach created by the funds.  The commentary, entitled Men of Steel – How Retail Investors Saved the Muni Market, was published in The Bond Buyer, but is available to subscribers only.)

Puerto Rico and Illinois: A Study in Contrasts

It certainly didn’t come as a surprise to anyone that the Illinois legislature conference committee again  failed to meet the July 9th deadline set by Governor Pat Quinn for coming up with a compromise pension reform bill. In retaliation, Governor Quinn has announced he will suspend legislators’ salaries, as well as his own, until the pension problem is resolved.

In contrast to Illinois, Puerto Rico’s new administration has been quietly effective in pushing through some much-needed measures to bolster market perception of its debt. Getting a pension reform package passed and validated by the Commonwealth’s Supreme Court was a positive first step. The Padilla financial team has also been on a mission to wean Puerto Rico’s key utilities (PREPA and PRASA) from general fund support and turn them into truly self-supporting entities. In that vein, the Puerto Rico Aqueduct and Sewer Authority Board of Directors voted last week to increase water rates by 60%, a move that should put the Authority on a solid path to self-sufficiency (There is some additional upside here if the Authority can somehow improve its historically poor revenue collection record).

Of course, PRASA is only one among the myriad fiscal headaches faced by the Padilla Administration. The Government Development Bank (GDB) has also been under scrutiny for the loans it has made to the Puerto Rico Highways & Transportation Authority (PRHTA). A potential default by PRHTA could prove the undoing of the GDB and set off a chain of events that even the most ardent critics of the Commonwealth’s fiscal practices would not dare contemplate. Thus, it came as a relief that, on Wednesday, the Puerto Rico legislature and governor approved two acts to provide additional revenues to the authority: $62 million per year in car license fees, $189 million in petroleum taxes and $30 million in annual cigarette taxes. Thus, in contrast to Illinois, the problems in Puerto Rico are being identified and systematically addressed.

None of this is meant to imply that Puerto Rico is out of the woods – not by a long shot. At the end of the day, solving fiscal problems with higher taxes could prove self-defeating, particularly given the island’s continuing economic slump. Despite being the lowest-rated state in the nation, Illinois is nowhere near the dire straits currently facing Puerto Rico and its problem is one of political will rather than fiscal distress. That being said, politicians in Springfield, Illinois could certainly take a lesson from their colleagues down in the Caribbean.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author and Axios Advisors, who are solely responsible for the accuracy and completeness of this column.  This column does not reflect the position or views of RICIC, LLC or MuniNetGuide. 

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