Muni Trends to Watch in 2024

Each year brings unique opportunities to the municipal market. In 2024, we expect the U.S. economic environment, individual state laws, and the challenges facing municipal sectors to offer favorable investment conditions.

Muni Supply Expected to Increase

We expect muni issuance in 2024 to outstrip the $380 billion in 2023. Municipal borrowers have had time to adjust to higher borrowing rates and the higher cost of project construction. As a result, the deal size of the many projects shelved over the past few years will not only come to market, but they will be larger. The need for infrastructure maintenance continues to be high, and the uptick in transportation-related revenues will lower the hurdle to entering the market. In addition to the pent-up demand and real needs, presidential election years usually see a spike in issuance. For a market that has long demanded more paper, 2024 should provide some relief.

Performance

As growth decelerates, inflation stabilizes, and the possibility of rate cuts looms, we urge investors to take advantage of the current elevated yield environment. We foresee a downward trend in yields for 2024, pointing to a potential total return opportunity. Between these current measures by the Fed and its recently expressed views, the second half of 2024 should produce returns consistent with other historical periods of ebbing inflation and healthy economic activity.

Absent anything but a modest increase in supply, we anticipate investment grade spreads to hover between 70 and 85 basis points (bps), capturing mostly normal relationships. Any trend towards capturing more duration spread (long demand) for greater returns will be on the heels of lower-rate moves. Muni high yield spreads will likely be held hostage to building credit concerns. A median benchmark of 250 bps might be challenged by 300+ bps in this sector if credits deteriorate. Lower issuance and an increase in demand for yield will follow a move lower in rates and can still give the high yield products a boost in total return because of the embedded longer duration bonds from all sectors.

Sector Watch

Local government borrowers find themselves in a strong position in 2024. As home values escalate, inflation drives up the cost of goods and services, and median income increases, the related property, sales, and income tax revenues grow commensurately. Cities and counties are in a better position to keep up with the higher expenses they face as well as refill their rainy-day funds this year.

On the other end of the spectrum, there is currently no better example of credit sector disparity than healthcare. A confluence of workforce labor shortages and increased costs of supplies and drug prices has resulted in most hospitals seeing double-digit increases in expenses between 2019 and 2022¹ with continued increases in costs in 2023. Combine this with slower increases in Medicare reimbursement, and the unwinding of the COVID Medicaid expansion in May 2023, and the overall fiscal deterioration is grave.

As we continue to invest in hospitals, we search for the organizations that show the most resiliency. Strong management, competitive markets that increase merger potential, and a sustainable payor mix are current focuses as we mine for the best opportunities.

Tax Changes on the Horizon

Many of the Tax Cuts and Jobs Act changes expire at the end of 2025, so 2024 is the time to start planning for anticipated changes and contingencies. Democrats and Republicans have both indicated interest in extending some or all the provisions, but a final package and its ramifications are ambiguous.

The two expiring provisions that most directly impacted the demand for municipal bonds are the change in personal income tax brackets and the AMT, Alternative Minimum Tax. In 2018, the top personal income tax bracket decreased to 37%. Without an extension of this provision, the highest personal income tax rate will return to 39.6% on January 1, 2026. As a tax-exempt investment vehicle, the attraction of the bonds and their price is correlated to the level of tax exemption. The impact of the AMT was significantly reduced by the Tax Cuts and Jobs Act. The changes reduced the number of AMT taxpayers to 200,000 from over 5 million in one year.² Changes, and anticipated changes, to the tax code will be felt in the market. Municipal debt continues to be a good investment vehicle in the face of tax uncertainty.

Sources:

¹ The Financial Stability of America’s Hospitals and Health Systems Is at Risk as the Costs of Caring Continue to Rise: American Hospital Association 17% increase in hospital expenses between 2019 and 2022.

² Tax Policy Center Briefing Book; Tax Policy Center; Urban Institute & Brookings Institution.