The jobs data giveth and the jobs data taketh away. Once again, the closely-watched monthly indicator of employment growth in the US caught all market observers leaning the wrong way. As shocking as the November number was on the high side, the December report turned out to be equally shocking on the low side: the 74,000 payrolls gain came out well below Street expectations of around 200,000.
Even more puzzling was a huge 0.3 point drop in the unemployment rate, to 6.70%, the lowest since 2008. The answer to this apparent contradiction: a large drop in the labor force participation rate, to a 35 year low of 62.8%. Apparently, 347,000 potential workers just disappeared from the work force!
Shrugging off all the volatility on the taxable side, the municipal market has quietly outperformed Treasuries in the final weeks of 2013 and so far into the new year.
Although the monthly jobs data is notoriously volatile and subject to significant revisions, this serves as another reminder of the fragile nature of the current economic recovery. Against this backdrop, the potential for a major spike in interest rates is becoming increasingly more remote.
Whether this latest piece of news will be enough to stay the Fed’s tapering efforts remains to be seen. The minutes of the FOMC meeting released on Wednesday did show some degree of skepticism on the part of Committee members regarding the effectiveness of QE3 going forward.
Not surprisingly, Treasury bonds have rallied dramatically on the day, with the 10-year Treasury yields crashing through the 2.90% level again to reach 2.87% as of this writing.
Shrugging off all the volatility on the taxable side, the municipal market has quietly outperformed Treasuries in the final weeks of 2013 and so far into the new year. As of last night, according to The Bond Buyer, “the 20-Bond GO Index of 20-year general obligation yields fell seven basis points this week, to 4.68%. The index is at its lowest level since November 26, 2013 (six weeks ago), when it was 4.61%. The Bond Buyer’s Revenue Bond Index, which measures 30-year revenue bond yields, slid five basis points this week, to 5.34%, after reaching a 134-week high of 5.40% in December.” On the back of today’s Treasury rally, tax-exempt yields should decline further today.
One can point to improving technical factors as a key driver of the tax-exempt sector’s recent outperformance. Outflows from municipal bond funds have slowed to a trickle: funds that report weekly showed outflows of only $19 million for the period ended January 8, versus outflows of $1.47 billion the previous week. Long-term funds lost a relatively modest $222 million. High-yield muni bond funds actually recorded inflows on the week, at $50 million, in sharp contrast to outflows of $363 million last week.
Of course, it remains to be seen whether this newfound market strength will hold when real supply returns to the market.
With the Detroit bankruptcy case moving through the court in a reasonably expeditious manner (although the most contentious issues still loom down the road), credit concerns have also temporarily receded into the background. Most importantly, after enduring another round of investor anxiety to start the new year, the Puerto Rico sector is finally benefiting from some positive news.
First, the Commonwealth’s December revenues came in at a record $913 million, up 26% compared to last year and pretty much right on top of forecasts. According to Treasurer Acosta Febo, the revenue increases were attributable to two principal sources: (1) a doubling of corporate income tax receipts due to the gross profit tax enacted in Act 40; and (2) a 4 percent tax increase on foreign companies, also enacted this fiscal year. It’s fair to say corporate taxpayers are bearing the brunt of the Padilla team’s effort to stabilize the budget deficit. It remains to be seen whether the massive increase in corporate tax burden will hurt the Island’s competitive position in the long run.
Although [Puerto Rico’s] overall fiscal picture appears to be improving … economically-sensitive revenue sources continue to reflect a struggling underlying economy.
Of late, the Commonwealth has been very quick to trumpet revenue increases but has been less than forthcoming regarding the expenditure side of the equation, which is where the real problems lie. Thus, we were happy to see that, in FY2014 to date, General Fund spending totaled $135 million or 3.2% under projections. Interestingly, payroll expenses for the first five months of FY2014 was $19 million (or 2 percent) under budget. According to the press release, the lower expenses were attributable to a “reduction of 8,300 employees paid from the General Fund” (from the wording, it’s not clear whether these were actual net layoffs or if some employees were simply shifted to other cost centers).
Not everything is coming up roses, of course. In spite of the improving overall revenue picture, the main security source for the Commonwealth’s lifeline to the capital market, the COFINA debt, continues to disappoint. Through the first six months of the 2014 fiscal year, sales-and-use tax revenues have come in $63 million or 10.4% short of expectations.
So, as Led Zeppelin would say, “the song remains the same.” Although the overall fiscal picture appears to be improving, primarily on the back of corporate taxpayers, economically-sensitive revenue sources continue to reflect a struggling underlying economy.
Our optimism is also tempered by another disquieting recent development: Puerto Rico’s government is taking steps to shift up to $2.8 billion in public deposits from private banks to the GDB in order to improve the bank’s liquidity. For the government to suck more capital out of the private banking sector sounds like a desperate move to us. It also raises the risk of a credit crunch for the Puerto Rican economy, something it can ill-afford at this juncture.
Thus, at least for a few days, muni investors can breathe a little easier with a more constructive rate outlook and a little less pressure from market technicals. As you know, less pressure is always helpful, particularly if one is sitting in traffic over the George Washington Bridge!
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