Muni Market Rebounds as Technical Pressures Ease, States Face Fiscal Strains: Rinehart

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00:00Shannon, let's start with this underperformance. Is there technical reason for this or does the

00:05underperformance reflect more fundamental issues? That's a great question. And our view is this was

00:12largely driven by technical factors. We did absolutely have a lot of uncertainty coming

00:18into the one big, beautiful bill, uncertainty around tax exemption, generically speaking,

00:23and that pulled forward a lot of supply. That supply just wasn't met by enough buyers.

00:30And when we layered in questions around tariffs, concerns around federal spending and pass-throughs

00:36to the states, we just did not see enough buyers stepping up to absorb the second year of record

00:43supply that we're seeing. So the good news there is fundamentals remain strong. And what we've seen

00:48recently is a recovery of that technical sell-off. So speaking of the federal government, we are in

00:54day 30 of this government shutdown. And however this eventually gets resolved, hopefully soon,

00:58it is clear that under this administration, there's going to be less federal funding available,

01:04including to state budgets. How are you thinking through that? How is the market thinking through

01:08that? Right. To your point, most of the federal funding that comes to states is impacted by the

01:15big headline, which is Medicaid. That's about 60 percent of the revenues that states receive from our

01:21federal government. So the cuts there are real, and they're going to be felt pretty swiftly at the

01:25state level. They do have a couple of years to figure out what they're going to do. And there's

01:30really only two opportunities for them. They're either going to need to cut coverage, or they're

01:36going to have to make some really difficult decisions in terms of what else in their budget

01:40can be cut. And what we've been seeing recently is a very varied response in terms of the political

01:47willingness at the state level to make these difficult decisions.

01:51Okay. And one example of that would be California. You say it's kind of the glaring example of a state

01:56that does not have a revenue problem, but might have a spending problem. And is that risk of being

02:01downgraded?

02:02Absolutely. So California has revenues that are more than 50 percent higher than they were pre-COVID.

02:09So that really supports our view that this is not a revenue problem. Instead, they've essentially

02:17ramped up their spending to exceed that revenue. And even on the back of 20-plus percentage equity

02:24market gains, they're dipping into their reserves. That's not what we want to see during periods of

02:30macro strength like this.

02:32So if California does get downgraded, what would that mean for the appeal of its bonds?

02:38Right. So it's important to note this is a double-A credit. So we're talking about a credit

02:44downgrade from double-A to single-A, still very, very strong. It's not at risk of, you know,

02:52a 28-esque default. You know, that's not what we're talking about. We're talking about a notch

02:57downgrade, still very strong. It's just not the behavior we want to see.

03:02Right. Right. When might that happen? What will be the catalyst for that happening,

03:06do you think, Shannon?

03:06Sure. So we are anticipating it could happen as early as this summer. And because of that,

03:14you know, our investments really favor things like local GOs, public schools. Those are financed

03:20by property taxes, much more reliable. And their taxpayers are much more likely to support

03:29the revenues that back those bonds.

03:31Right. Gotcha. Shannon, before I let you go, what tends to happen in the fourth quarter for

03:35munis as we wrap up 2025?

03:38Right. The good news from the technical front is supply tends to dampen a bit here. And that is

03:45one of the key reasons that we're pretty constructive, that we will continue to see our yields grind

03:50tighter and we should achieve the year of carry for 2025 that we had forecasted.

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