Movin' On Up
The Federal Reserve announced a short-term interest rate hike on Wednesday, the first one in a year and a move that was largely expected. But what wasn’t on the radar was the Fed's announcement that it plans to raise rates three more times in 2017, up from previous expectations of two rate hikes.Given the reticence to move rates for most of the last decade, the faster pace for next year has municipal analyst Chris Mauro calling the decision a “rather splashy hawkish surprise.”
The rate hike will move the target interest rate on short-term debt up one-quarter of a percent -- to a range of 0.5 to 0.75 percent. The Fed's previous rate hike was a year ago, and that was the first one in nine years.
The Takeaway: The Fed's plan to raise rates signals that economic growth is accelerating. A strengthening labor market and moderately growing economic activity were each cited as the basis for the Fed's decision this week.
What does this mean for interest rates in the municipal market? It can be tempting to think that a rate hike will have a wide-ranging affect, but in reality it usually has a muted impact. Variable rate debt and other short-term bonds might see a slight uptick in interest rate costs, but long-term debt issued for infrastructure projects and the like won't see much of a change. In fact, experience has shown that a hike in short-term rates can actually cause a downward tick in long-term rates because inflation is dampened.
Long-term bonds, however, might face dangers elsewhere. Senior Moody’s Analytics Economist Dan White said this week that the anticipation of policy changes can sometimes have a more dramatic effect than the direct changes themselves. “For example, financial markets are already beginning to price in some fiscal stimulus from the incoming administration, and that has dramatically pushed up long-term interest rates,” he told procurement consultant Onvia. “Higher long-term rates will weigh on the pace of growth as early as the first half of 2017.”
Pay Up, Retailers
The U.S. Supreme Court this week turned away a case that challenged Colorado’s so-called Amazon tax.The law was enacted in 2010 and requires out-of-state companies selling products to Coloradans to tell them they are required to pay the state’s 2.9 percent sales tax on their purchase. Companies argued the law was too cumbersome to comply with and it violated interstate commerce rules.
The rejection of DMA v. Brohl from the nation’s top court was seen as a win in states’ long struggle to capture tax revenue on purchases their citizens make online. Generally, consumers are only taxed on purchases from retailers with a physical presence in their state. That policy was established nationally via a 1992 Supreme Court case, Quill Corp. v. North Dakota.
Matt Walsh, vice president of tax for Sovos Compliance, said other states may copy Colorado’s reporting requirements, which include retailer penalties for not submitting the reports correctly, completely or on time. "Some sellers," he said, "may decide that registering and collecting the state level tax may prove less of a burden."
The Takeaway: By refusing to hear the case, however, the "win" remains limited to Colorado. But that could be a good thing. The National Conference of State Legislatures has said that it doesn't "feel that DMA v. Brohl was the best case to reconsider Quill."
That best case to challenge Quill might just be one that’s now moving its way through the lower courts in South Dakota. The state passed a law that goes beyond encouraging compliance as Colorado did. It outright permits the state to collect a sales tax on Internet purchases from remote retailers who have a so-called "economic presence" in the state. Many believe the case could be fast-tracked to the Supreme Court as early as next year.
Borrowing From Peter to Pay Paul?
New Jersey lawmakers this week introduced a bill that would allow the state’s struggling Transportation Trust Fund Authority to sell bonds directly to the state’s underfunded retirement system.The transportation fund’s most recent bond issuance paid out 5 percent annual interest payments to investors, and state Senate President Steve Sweeney has said he expects the bonds would pay the same return to the pension system.
Pension funds investing directly in state infrastructure projects has its merits. Pension plans need to reserve some part of their portfolios for lower-risk, lower-return bonds (as opposed to higher-risk stocks). So why not keep that money in-house and buy bonds that have a direct economic impact within the state?
The Takeaway: The bill comes during troubling times for the state’s pension system and its transportation fund. The latter has been raided by the state to cover budget shortfalls, and this summer it ran out of money, forcing a temporary work stoppage on all state transportation projects.
Meanwhile, New Jersey hasn’t paid its full pension bill for more than a decade, leading to a massive $135.7 billion unfunded liability. The precarious pension situation was also the main reason S&P Global Ratings recently downgraded New Jersey’s debt one step to A-.
So, while the investment strategy has its proponents, not everybody thinks New Jersey should be the place to experiment with such a strategy.
Municipal Market Analytics’ Matt Fabian issued a harsh critique of the proposal, calling it "little more than NJ writing itself an IOU to make pension contributions later." Notable among his criticisms is that the strategy would expose an already weak pension system to a credit -- the state of New Jersey -- that is also weakening. "Expanding the state’s internal dependence on … its own credit quality," wrote Fabian, would "amplify downgrades when they do occur."
There’s also the pension fund’s own cash flow to consider. A 2014 reportlooking at this practice in Australia and Canada noted that “solvency and funding regulation can make long-term investing more difficult.”
In other words, it’s questionable if New Jersey can afford to loan money for several decades when one credit rating agency predicts the pension could run out of money in less than 15 years.
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