Muni Market is (Mostly) Unimpressed with the Infrastructure Bills

Posted by lplresearch

Tuesday, November 9, 2021

The Bipartisan infrastructure bill finally cleared Congress late last week and will be signed into law by President Joe Biden soon. The $1.2 trillion bill will increase new spending towards transportation and “other infrastructure” initiatives by $550 billion, spread out over five years. The law includes $110 billion for roads and bridges, $66 billion for rail projects, $42 billion for ports and airports and $39 billion for public transit. Another $73 billion will go toward updating the power grid; $55 billion is directed to drinking water and lead service lines; and $65 billion slated for broadband infrastructure. The Infrastructure Investment and Jobs Act would mark the largest federal investment in infrastructure in more than 10 years. Importantly, roughly $340 billion would flow to municipal issuers. This is certainly a positive for municipal issuers but, as we stated back on September 28, it is unlikely a catalyst for lower yields (higher prices).

“Demand for tax-exempt debt has been strong this year,” noted LPL Financial Fixed Income Strategist Lawrence Gillum. “Unfortunately, details coming out of Washington D.C. with these infrastructure bills are likely to slow some of that demand. Muni credit fundamentals remain strong though so we don’t think yields move meaningfully higher from these levels.”

The current focus for muni investors is what is, and consequently what is not, included in the Build Back Better bill, also known as the reconciliation bill. While details are still being worked out, unfortunately for muni issuers and investors a number of important provisions that would have increased the credit quality of the market and increased demand (such as the restoration of tax-exempt advance refunding, the creation of a direct-pay bond program, and a higher cap on the bank-qualified issuance limit) were all stripped from the bill under consideration in the House. Additionally, the likely absence of increases in individual tax rates reduces the demand for tax-exempt bonds. Moreover, the bill seemingly includes tax-exempt income as part of the 15% corporate minimum tax rate, which would likely dampen demand from banks and insurance companies, which make up approximately 25% of muni ownership. To say that these developments are disappointing would be a severe understatement. And, as shown in the LPL Research Chart of the Day, AAA muni yields relative to 10-year Treasury yields continue to move higher recently largely, in our view, because of these disappointing legislative developments for muni investors.

It hasn’t been all bad news for muni issuers recently. A bill called the State, Local, Tribal, and Territorial Fiscal Recovery, Infrastructure, and Disaster Relief Flexibility Act, which began as an amendment to the bipartisan infrastructure plan before evolving into its own legislation, provides municipalities with flexibility in how funds from the American Rescue Plan Act could be spent. State and local governments would be allowed to use a portion of their unspent COVID-19 relief funds for infrastructure and disaster relief under a bipartisan bill the Senate passed unanimously recently.

While performance for the municipal bond market is still broadly positive for the year (as per the Bloomberg Municipal Bond index), the last three months have been challenging. After what was a strong technical tailwind for the market during the summer months, the index has posted three negative monthly returns in a row; the first three-month losing streak since 2016. Demand for muni issuance remains strong however and municipal bond funds have seen inflows in 76 of the past 77 weeks, totaling a record $153.6 billion. After 44 weeks, the pace of fund inflows remains the fastest on record, and the current year-to-date inflow of $92.1 billion would be the second highest among full-year calendar inflows since the inception of the data in 1992. With the economy continuing to recover and with state and local tax receipts higher than expected, the tax-exempt market should remain well bid through the rest of the year.


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