Hallacy on munis

Chip Barnett: (00:03)
Hi and welcome to another Bond Buyer podcast. I’m Chip Barnett, and my guest today is John Hallacy, and he’s the founder of John Hallacy Consulting LLC. And today we’re gonna be taking a look at the state of the municipal bond market, where it is right now, and where it’s heading for the rest of the year. Welcome back to The Bond Buyer, John.

John Hallacy: (00:23)
Well thank you Chip. It’s a pleasure to be here.

Chip Barnett: (00:26)
Okay, let’s talk first about fiscal and monetary policy. You know, it appears that monetary policy is front and center right now, especially since the Fed’s the latest move. Where are we headed on the economic front?

John Hallacy: (00:42)
Well, Chip, you’re right to point out that monetary policy has really been predominating the discussion in all the fixed income markets. And obviously what the Fed is up to is clearly essential to the focus. One of the aspects that Chair Powell has discussed is that he desires positive real rates across the yield curve, and apparently that’s held by his colleagues on the committee as well. So, you know, we are going to have this upward trajectory for rates for some time. And even though munis don’t move always in lockstep with what’s happening with Treasuries, there clearly is a high correlation. The wildcard is muni supply. And coming into the year, people were pretty bullish about supply their supply estimates and they’ve largely backed off. A lot of those higher estimates have have brought them down.

John Hallacy: (01:55)
I think the range now is somewhere $425 billion to just under $500 billion, which is probably still too high on that higher level. So we’ll see what happens with muni rates and ratios over time as Treasuries adjust to whatever Fed tightening take place. And in terms of where we’re heading on the economic front, what’s really peculiar about this point in time is that the job openings are still so high and wage and employment growth is still pretty strong. Now, having said that, some companies now are starting to see the handwriting on the wall and are saying, you know, we have to reduce our ranks somewhat to maintain our profitability because our inputs are costing so much more now. So we’re starting to get some inkling that there’s going to be a little bit of slowing in the hiring, and we have may have some more significant layoffs, which means the economy overall will slow. And clearly that’s what the Federal Reserve wants to induce here in order to bring the pernicious inflation rate down.

Chip Barnett: (03:12)
You know in the media there’s been a lot of comparisons to the 1970s, but, there’s been few people looking at comparisons made with 1987. Do you think there are any lessons to be learned from that time period?

John Hallacy: (03:29)
Well, you and I Chip lived through the seventies and the stagflation, and it was just such a different time because rates were extremely high, but so was unemployment. Unemployment was definitely in the double digit range for, for quite a while, and it, it took a lot to bring all of that back into balance. ’87 was a little different year and I’m thinking a little bit more of what was happening broadly and then what was happening in municipals. Clearly there was a stock market crash, if you will, that October, and there were a lot of layoffs and unemployment started rising. But you know, what also happened was that muni volume really started to stall with the somewhat higher rates that were prevailing in. As you’ll remember, I believe it was Solomon Brothers was not the number one underwriter at the time in municipals, and they decided to withdraw from the municipal market, which was just unprecedented at the time. And I’m a little concerned about where we’ll go with the municipal industry. Well, hopefully it’ll remain profitable and underwriting spreads will remain strong enough to keep a good robust, uh, uh, retina of underwriters in the market. But we’ll see what will happen there.

Chip Barnett: (05:06)
You know, all rates have risen, but, you know, the brunt of this change has been felt mostly on the short end. What do you see going forward?

John Hallacy: (05:14)
Yeah, it is interesting that the short end is cheapened so much, in the long end, of course has as well, but not as nearly as dramatically and I’m wondering again bringing the discussion back to municipals, well, some of the issuers start to think of issuing variable- rate bonds. Again, it hasn’t been done as much in some time as you know, because fixed income rates have been so advantageous and, and in some cases, uh, were unprecedented, unprecedented in terms of how low they were have been. But we’re entering a very different period now, and, uh, I’ve heard some commentators say, Well, why not just buy Treasuries, two-year Treasury at 4% and sleep better at night? And the muni curve hasn’t exactly mimicked what what’s going on in Treasuries on the short end of the curve. So it remains to be seen if we’re gonna cheapen up more munis on the short end. But there’s so much retail demand on the shorter end that that tends to serve to keep rates somewhat lower than they might ultimately become.

Chip Barnett: (06:35)
You know, most of the strategists have lowered their, uh, muni bond volume estimates for this year. What’s your take and what’s it looking like for next year?

John Hallacy: (06:45)
Well, again, uh, coming into the year, everybody had some pretty robust estimates and now they’re in the $425 billion range. I mean, I think we could easily end up the year, say in about the $450 billion range, which wouldn’t be too far off last year, but I think some of the issuers now are adopting more of a wait and see attitude towards coming to market. That doesn’t mean they won’t well at some point during the year, but I think the approach might be a little bit more cautious next year. Obviously if you’re in a large construction project and you need more funding, it’s much more expensive to halt financing the construction activity then to continue with it. But there may be some delay in terms of undertaking new projects going into next year. So I certainly think next year’s issuance will be lighter than this year. How much, I can’t say at this point. We might get a little better read as we get towards the last couple of months of the year.

Chip Barnett: (08:03)
Do you think variable-rate issuance is gonna accelerate?

John Hallacy: (08:07)
I do. The real question there is, when it was really popular the last time you did the variable- rate issuance along with a swap, and basically a lot in a lot of cases, that swap was intended to cap interest rates on, on the other side. And, the muni market has largely got gotten away from swaps except perhaps for the healthcare sector. So I don’t know that issuers would readily embrace swaps again, but they might do some modest amount of variable- rate debt without a swap, a so-called naked variable-rate debt. And it tends to be the larger issuers who are able to engage in debt.

Chip Barnett: (09:00)
Personal income tax revenues have been slowing in several states, including in California. What’s your outlook for personal income, retail sales and corporate tax revenues for the rest of this fiscal year?

John Hallacy: (09:13)
Well, the personal income taxes clearly are geared towards employment and wage growth. And wage growth has been fair, uh, pretty favorable overall as we’ve been discussing, but the stock market actually hasn’t helped a lot in terms of unearned income. And for some states like California, New York, uh, and what have you, uh, Connecticut and in some cases even, um, uh, other states, the unearned portion is, is can be very important and can be as much as double digit range of the total personal income tax take. Um, so clearly, uh, for some folks gains are down this year and they have plenty of offsetting, uh, losses to, uh, help zero out their, their gain liability when it comes to tax time. So there’s definitely gonna be further softening personal income, uh, retail sales, you know, just when you announce the death nail for retail sales, it seems to perk up and retailers are, are pulling out all the stops in terms of techniques to, uh, to push the goods.

John Hallacy: (10:32)
So, I think retail sales will continue on a modest growth path this year. They won’t be super robust, but they’ll be positive enough, they won’t be negative. And in terms of corporate tax revenues, you’ve had some new tax policies enacted at the federal level. It’s a little unclear how that will filter down to the states, but I think net there, there would perhaps be more offsets to tax liability. So I would think that the corporate tax would be unchanged to lower this year as well.

Chip Barnett: (11:19)
Okay. And we’ll be right back after this important message and we’re back talking Munis with John Halley. You know, a lot of people say ratings tend to be viewed as lagging indicators. What’s your view of where we are in this rating cycle right now?

John Hallacy: (11:38)
Well, the raters have a difficult job no matter what time period you’re talking about and unfortunately, a lot of the financial information is lagging as well in terms of not being close to real time at all. And we’re going to be getting more audits for the June 30 fiscal year coming out in the Fall and into early next year. You know, I think the raters are trying to be sensitive to changes in the economy and changes in the finances, but I think it’s still hard to not have some of the lag in rating actions because, simply they can’t act in advance of when some of the information becomes available. So you still see some upgrading going on based on history and going into next year. I am somewhat fearful that there might be some more downgrade pressure coming,

Chip Barnett: (12:51)
ESG and climate change are hot topics, no pun intended. How should these be considered in the fundraising process? You know, what kind of disclosure would be considered acceptable to all the interested parties?

John Hallacy: (13:07)
Well, on the ESG front, I really feel like that’s demand pull from the buy side. If the buy side is opting to consider ESG eligible bonds, that’s their preference. And if they want to pay up for that, that’s also their preference. So I, I think given the posture on the buy side that there’s a favorable attitude towards ESG bonds, I think they’ll continue to be issued. And in terms of climate change, clearly the emphasis is on cities that are particularly prone to specific climate change events such as New Orleans with hurricanes and flooding and out West you talk about wildfires and earthquakes and what have you. But in terms of climate change disclosure, that’s real art versus science, there’s always a consideration about about how much disclosure is enough and how much is appropriate. If you ask an analyst, they’ll always want more and more disclosure. If you ask a banker, they’ll say, we wanna include certainly what is sufficient, what is necessary and required, but we don’t want to go into the realm of speculation. So I think that’s a real dynamic process that we’re gonna have to keep watching over time.

Chip Barnett: (14:53)
Electric vehicles. How is an increasing level of theses on the going affect the transportation sector?

John Hallacy: (15:02)
Well, it will affect on a of sectors and certainly the power sector in terms of transportation sector, you know, we have a lot of gas tax bonds out there that would have to probably be potentially restructured or reconsidered as the EV penetration continues to push higher. I mean right now I’ve heard it’s only around 6%, so we’re nowhere near that stage yet, but when, you know, when it starts getting up to 50%, that’s gonna have a real impact on those both federal and state gas tax levels. So we’ll need to keep monitoring that over time and see if we need to, uh, recalibrate also the movement to some kind of tolling or vehicle miles traveled. VMT might be more necessary as we go further and further to the EV route. All of this is developing as we speak, but the other aspect is not for the hybrids, but for the plugin EVs, you know, the power sector is gonna have to keep providing, ultimately they’ll have to provide more generation to meet the demand over time. And the push has really been on alternatives and getting away from fossil fuels over time. And in terms of alternatives, it’s all about reliability. So we’ve seen some people saying, Well, let’s, let’s do some more nuclear again, of course it’s has had a real challenging history over time, but clearly the power sector is going to have to include some better estimates in the EV penetration and their load growth forecasting over time. So that I think will be a real interesting aspect as we go along as well.

Chip Barnett: (17:08)
Do you have any thoughts on how the midterm elections may affect public policy?

John Hallacy: (17:13)
Well, there’s certainly been a lot of prognosticating going on. I mean, whether or not the the Republicans have a better showing or not is, is certainly not a foregone conclusion. We won’t know until after the polls close, but if the Republicans recapture a key number of seats to sway votes, that could have a real impact on some of the policies that have been made of late. So, it’s still too early to call, even though it’s not that far away. But anytime you have these elections, it could bring about real change, so we’ll anxiously wait to see what the results are in election day.

Chip Barnett: (18:13)
Is there anything else that I might have missed or that you would like to add?

John Hallacy: (18:17)
Well, you know, we haven’t talked about the pandemic at all. Of course, there’s been a declaration that the pandemic is over, but that doesn’t mean caseloads are zero and that we still do not have some real challenges with it. I mean, clearly we’re getting more booster vaccines again and that that should help. But, I think we still have to stay a little wary of what might happen if pandemic was here if we get another variant or not, we won’t know that until we get deeper into the Fall and Winter. And of course, there’s a war in Ukraine, which is a total wildcard, and that that’s causing a lot of concern on a lot of fronts. And, it seems like Putin’s stepping up the effort again. So we have to be diligent about following what goes on there, especially with its effect on sectors and ultimately on rates.

John Hallacy: (19:27)
And of course, mortgage rates have shot up over 6%, and that’s pretty much a doubling of where, where they’ve been, uh, over the last year. And the housing supply is still only about 3.2 months of supply. So, why do I mention this? Localities rely on the property tax, which is based on real estate valuations and basically less turnover in the housing sector means a little slower valuation growth over time. And, uh, you know, that tends to, that real estate property tech cycle tends not to react as quickly. But, uh, there will be a bit of a reaction at some point, but we haven’t seen it yet. So I would say stay tuned for that one.

Chip Barnett: (20:24)
John Hallacy, thank you very much for being with us today.

John Hallacy: (20:27)
It’s my pleasure, Chip.

Chip Barnett: (20:29)
And thanks to the listeners of this latest Bond Buyer podcast. Special thanks to Kevin Parise who did the audio production for this episode. And don’t forget to rate us, review us and subscribe at For the Bond Buyer, I’m Chip Barnett, and thanks for listening.

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