A Long-Distance Relationship

by Deidra Krys-Rusoff Senior Vice President

Municipal Bonds Attract Foreign Investors

U.S. stocks ended the week near record highs with the S&P 500 trading above 2,170 and the Dow above 18,545. A gain for the week would mark the fourth consecutive weekly advance.

The dollar strengthened on speculation that global central banks aren’t in a rush to add to unprecedented stimulus. In aggregate, U.S. economic indicators were positive for the week, such as the Purchasing Managers Index and housing starts, which presents further evidence that the economy is gaining traction. The benchmark 10-year Treasury closed the week unchanged, yielding 1.55 percent.

Brexit, negative interest rates and increased global market volatility have resulted in greater flows of foreign capital into the municipal market. The Federal Reserve’s flow of funds data revealed that foreign holdings of municipal debt rose to $89 trillion, up over $2 trillion in just the first quarter of 2016. We believe this is a direct outcome of foreign investors seeking positive yield in more stable markets and away from the negative yields oversees.

Why would foreign investors be interested in local government bonds? Many state and local governments are modestly growing, which is attractive to foreign investors seeking safety and stability. Georgia, Tennessee and North Carolina are examples of states benefitting from revenue growth beyond their expected yearly projections. In addition, Tennessee and Hawaii’s credit ratings were recently upgraded by Standard & Poor’s.

Not all states are sharing in the growth. New York reported yesterday that first quarter personal income taxes were down, reflecting the slowdown on Wall Street. This was partially offset by increases in sales tax and business tax revenue. Alaska, North Dakota, Oklahoma and Wyoming are also expecting revenue declines and volatility this year due to the effect of lower oil and coal prices.

Also, some states are losing direct sales tax revenue due to an increase in online shopping. Estimates of the tax losses are in the billions of dollars. Current laws allow some states the ability to tax business entities that have a physical store or warehouse in state, as established by a Supreme Court ruling in 1992. South Dakota is trying to mitigate revenue losses by establishing a law that will tax online sales based upon volume of sales (greater than $100,000) or quantity of sales (greater than 200). South Dakota’s law was written with the intent to directly challenge the 1992 ruling. Many states are awaiting the outcome and stand willing to draft similar laws should South Dakota win its challenge.

Our Takeaways for the Week

  • Recent market volatility and low global yields have increased foreign interest in state and local municipal bonds
  • Overall state revenue growth is increasing, but not all states are participating in the growth