2024’s community finance crossroads: Volatility amid quiet construction

Brace for an unpredictable year in community finance, where a confluence of global turmoil, mandatory tech advancements, legislative implementation, and potential political upheaval all collide with an already fragile insurance market. While the presidential election may be a noisy stalemate, this chaos presents a hidden opportunity for agents of change to make real progress. Think private tech solutions for public entities, strategic bond issuances, and innovative solutions to climate-induced risks.

Themes to watch:

• The coming technological tsunami: The Financial Data Transparency Act will move the municipal market into the digital age, streamlining disclosures and opening doors for data-driven solutions. The coming year will be a behind-the-scenes process but its outcomes will be up front and center over the next decade. 
• ESG clashes: Blue cities in red states will face financial pressures as environmental and social issues continue to instigate friction. With that said, federal legislation related to muni securities will find green and blue labels so issuances of these flavors should continue to increase over the next twelve months. 
• Lead pipe problem: The EPA’s new rule on replacing lead service lines will squeeze local governments, demanding creative financing and innovative solutions like impact bonds to address the clean water problem.
• Energy showdown in court: Renewable energy’s rise will challenge energy monopolies, sparking legal battles that could reshape the grid.

The bottom line: 2024 won’t be a year of dramatic change, but it will be a year of laying the groundwork for a more resilient and sustainable future.
Rates & presidential politics
Historically, the one thing that would be certain during times of global uncertainty is the flight-to-safety bid — people buy U.S. Treasury bonds as a retreat from chaos — which means the bid for municipal bonds also improves. The problem with this historical certainty is that Fitch Ratings downgraded the U.S. earlier this year, affecting Treasuries, and we have what looks to be an absolutely chaotic presidential election pending. Given all this, it is hard to make the case of a bid-to-safety into such an asset class.

Labor conditions, inflation, etc., all look to be on stabler footing, but Court Street Group sees presidential polling headlines as dominating market movements more than anything else in 2024 and that will likely make for volatility within the ranges that have been set over the last month. In the first quarter of 2024, House Speaker Mike Johnson, with the tacit support of team Trump, will shut down the government. The gamble that people will point the finger at President Biden and not the Congress (or at least not candidate Trump) will play out poorly and some half-measure will be reached in the early Spring. 

Any way you slice it, broader rate momentum will be headline dependent and have less to do with traditional fundamentals and technicals.

On fundamentals & technicals
Unaddressed infrastructure, cyber security, social/environmental challenges and pensions are the standard talking points. Election years historically see more issuance in the first three quarters as issuers lock in certainty before November. 

On taxes, we would add to the mix that 2017’s tax cuts sunset in 2025, which could start to be priced into the market depending on how the presidential race shapes up. COVID-related funds are getting tapped out as well and that is going to be a negative vector on certain local government, urban names.

According to the Center on Budget and Policy Priorities, from 2021 through 2023, 26 states cut their personal income tax rates and/or corporate income tax rates, 13 of them multiple times. The scope of cuts are now larger than those seen in the wake of the Great Recession. That is a big figure and deserves pause. To counter that, the National Association of State Budget Officers reports the highest aggregate of state rainy-day funds in history.

Market structure
There was a moment this October when, on a trading floor, someone commented something to the effect of: “I’ve never seen a sell-off like this where I am not seeing an uptick in institutional bids-wanteds.” The data on that day shows the bids-wanteds on Bloomberg were average, but the market tanked under a deluge of motivated sellers. If you looked at sellers of odd-lots and below the $1 million market in general, it was well above average.  

In October the market saw a massive transfer of risk from mutual funds to ETFs/SMA accounts taking advantage of the historical anomalies that occurred during that time (ratios, etc.). Enter November, with less calendar and a drop in the bids-wanteds and peak ratios, and the month saw the best performance on record. The so-called herd that is municipal rate direction has become more concentrated and unidirectional. That this market cannot be properly and/or efficiently hedged plays into this vector. 

This is an important and basically non-reported aspect of the market structure of the municipal bond market right now. The growth of separately managed accounts, exchange-traded funds and essentially a larger decentralization, or less concentration, of securities in a few big hands, has implications for volatility in the secondary marketplace, which also impacts borrowing rates for communities. 

These asset management vehicles are growing for a variety of reasons, but the biggest driver is cheaper access to investments via ETFs, and technology in general, has democratized access to the asset class (yay!) but this becomes problematic when one considers the unique way in which municipal bonds are issued (serial maturities) and traded (over the counter). We are in a time when the behind-the-times process of tagging and labeling securities makes for a slow and cumbersome trading process (T+?) mixed with a new dynamic of distribution of ownership (and pitifully low broker/dealer holdings) will make for increased volatility in 2024.

Quick takes:

• Historically Black Colleges and Universities win on the Supreme Court decision on enrollment and it will play out in the marketplace. 
• The melding of green and affordable housing will make some real headway as programs to retrofit and weatherize along with grants and tax-incentives per federal and state initiatives kick into gear and there will be an uptick in bonds to support such initiatives. 
• State bond banks will get some time in the sun as data will start to trickle out that states with this type of financial infrastructure in place are better situated to take advantage of the deluge of federal dollars enacted in the last three years.
• Impact will move beyond a label. The Chicago social bond that took a step at making municipal bonds more tangible to the community will be seen as a turning point for the marketplace. It is not about a label, or an investor model, it is about state and local governments making the change to embrace impact that will result in real, thoughtful, meaningful change in the way communities raise capital in this country. 
• In urban areas, the conversion of commercial to whatever it is a mayor decides, should be monitored as there will be winners and losers here as long-term commercial leases will be coming up for renewal.
• The void left by Ted Leonsis in downtown Washington, D.C., will become a casino and the WMATA budget shortfall is only a glimpse of what is coming.

To read the full CSG new year outlook, you can click here.