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Outlook 2019

Since 1992, Smith's Research has conducted an ongoing study of municipal default risk. From its inception, Smith's Political Event Risk has been a critical tripwire for default risk for municipal bonds.

Smith's Political Event Risk Covers (classes):

1) Currency inconvertibility (CI) and exchange transfer (FX);

2) Confiscation, expropriation and nationalization (CEN);

3) Political Violence (PV) or War (including revolution, insurrection, politically motivated civil strife, terrorism);

4) Breach of Contract, Contract Frustration (CF), Contract Repudiation.

5) Wrongful Call of a Guarantee (WCG).

During the 2008 Subprime Mortgage Crisis, the U.S. government made a wrongful call of a guarantee by providing a 100% full-faith pledge to Fannie and Freddie Mac. Under the Government Sponsored Enterprise (GSE) enabling legislation, only 10% was guaranteed by the U.S. Treasury.

Currently, the yellow-vest movement (gilets jaunes in French) are engaged in political violence to rollback social engineering programs launched by the Macron Government.

When the U.S.S.R. collapsed in 1992, and more recently, Argentina, the inability of the government to rollover its sovereign debt in the international markets resulted in the placement of the sovereign debt in the state and local pension plans.

In 2000, Smith's Research hosted the nation's first municipal bond conference on the risk of unfunded public sector pensions as a symptom of. heightened political event risk. In 2001, Jorge Irrizary, then President of the Puerto Rico Government Development Bank, discussed why the island's unfunded pensions were critical concerns being ignored by the rating agencies.

 Smith's Research & Gradings will be talking more about Political Event Risk and why it is important throughout 2019.



MAGNY: Demographics and Migration

The Municipal Analysts Group of New York (MAGNY) hosted it first luncheon of the year on Friday, 11th of January. The subject of discussion was: U.S. Demographic Change, Ratings, and Interstate Tax Migration.

Major U.S. demographic changes driven by continued high levels of immigration, changes in state tax law, the aging of the Baby Boomers, and a slower rate of family formation by Millennials have been generating a great deal of interest in the national media and the public finance community. Commentators have presented a variety of views, ranging from demographic change having a muted effect on municipal finance to full-bore "doom and gloom" scenarios.  The objective of the MAGNY event was to sift through the noise and provide members with informed commentary and opinion.

MAGNY had four expert panelists who discussed the relationship between forecasted U.S. demographic change and state and local creditworthiness including the existence or non-existence of interstate tax migration and what is driving it.


Northern Trust Outlook:First To Neutral

Northern Trust Asset Management revealed its Outlook for 2019 entitled "First to Neutral.  Mr. McDonald, CIO, prefaced, "As we enter 2019 with the global economy slowing, U.S. monetary policy tightening and trade tensions introducing further risks to a slowing China. We don't expect a recession to unfold over the next year, but the current rise in volatility reflects the increasing risks to that outlook. In this lower return environment, we like the return prospects for U.S. high yield bonds, which should benefit from a relatively strong current yield and strong fundamentals. We expect this to reduce downside risk but also offer good upside market participation. We entered 2018 with a significant overweight to risk assets, but we steadily pared that back during the year as risks increased around growth and monetary policy.

"We moved to neutral risk before the Federal Reserve got to its "neutral" rate of interest, as our concerns built around the Fed over-tightening. Our "first to neutral" approach also captures our view of risk taking today — as the outlook for 2019 is hazy, we have gone first to neutral as we assess our next move."






5 Years  Ago

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The unemployment rate declined from 7.0 to 6.7 percent in  December, and nonfarm payroll employment edged up (+74,000), according to Erica Groshen, Commissioner  of Labor Statistics. She testified last week before the Joint Commission that monthly job gains averaged 182,000 in 2013, about the same as in  2012. In December, employment rose in retail trade and wholesale  trade but fell in the information industry.

She testified, "Incorporating the revisions for October and November, which increased employment by 38,000 on net, monthly job gains have averaged 172,000 over the past 3 months."

Retail trade added 55,000 jobs in December. Job gains occurred in food and beverage stores (+12,000), clothing stores (+12,000), general merchandise stores (+8,000), and motor vehicle and parts dealers (+7,000). Retail trade employment increased by an average of 32,000 per month in 2013.



Two reports — one by Moody's, and one from Citi's Muni Trading Desk Strategy team, help provide a context for assessing state and local credit risk.

George Friedlander, municipal strategist at Citi concluded that the risks of downgrades on state and local debt is significant, but that the ultimate number of payment defaults stemming from this downturn will be modest — assuming that the stimulus package incorporates state and local support as he envisions.

Moody's noted that "Many local governments will face difficult fiscal choices and a minority will face material stress over the next few years. The downturn in real estate problems has exacerbated the problem…few local governments will escape the difficult choice between raising taxes in the face of local government stress and cutting services in order to balance their budgets.




The Outlook for 2004 is dominated by the huge federal deficit and record trade deficit. In its December 15, 2003 edition, Smith's published a report underscoring the importance of these two deficits.  Smith's found these two deficits produced an unprecedented amount of US$ denominated securities being purchased by foreign investors AND the equally unprecedented amount of US$ denominated securities being sold by foreign investors.

The dramatic ebbs and flows in the world capital markets has produced enormous volatility in the fixed-income markets.

Smith's has examined the current trade account deficits and currency rates. Consider for a moment, as we did,  the Euro and major currencies have soared over 18% in relationship to the US$, while the People's Republic of China's Renminbi (translates as "People's Currency") has remained comparatively constant in exchange for the US$.








John Hallacy, director of municipal research at Merrill Lynch, was asked about the non-binding vote in Puerto Rico. He responded, “The vote was something of a surprise given the economy’s strong performance and local government’s ability to maintain healthy financials. There are still questions about the phase-out of the Section 936 subsidy. But, the vote indicates the subsidy cut may be more of a consideration over time.”  When asked if there are any factors that might prompt the issue of statehood to become more pressing for Puerto Rico, Mr. Hallacy said, “Sure. Mexico has stabilized quite a bit, although the prices of commodities are still down.”

To wit, Smith's interjected, “you mean oil?”

He said, “Exactly. Under NAFTA [North American Free Trade Agreement] Mexico could prove to be more competition for Puerto Rico.”


December 14, 2019, Vol. XXVII, Issue 1  Municipal Edition


The Global Economic Doctor

January 3, 2019, Brief View



Looking into 2019


Manufacturing: The Trend May Not Be Our Friend

One key indicator for global economic growth is manufacturing as measured by PMI (Purchasing Managers’ Index) data. Although the global economy is not signaling that a recession is just around the corner, PMI data for December demonstrated a continued slowdown in China, the United States and the Eurozone (see below).  While the U.S. and Europe remain in positive territory (above 50), China slipped under 50, which is taken as a contraction.

U.S. data indicates a weakened pace of expansion in late 2018 and less upbeat prospects for 2019, the latter reflected by output and order books growing at the slowest rates for over a year, while optimism slumped to its “gloomiest” in two years. Chris Williamson, Chief Economist at HIS Markit, observed: “Some of the weakness is due to capacity constraints, with producers again reporting widespread difficulties in finding suitable staff and sourcing sufficient quantities.”  The report also noted the impact of tariffs. On January 3rd the ISM U.S. Manufacturing index report for December reflected this more bearish sentiment, coming in at an unexpected 54.1, down from November’s 59.3, which was a jolt to markets. The consensus estimate was 57.9. Moreover, the news of a slower pace of factory activity in the U.S. coincided with news from Apple that it was slashing its holiday-quarter revenue forecast due to slower-than-expected sales from China.

In China the Caixin/Markit Manufacturing Purchasing Managers’ Index (PMI), a private survey, fell to 49.7 in December from 50.2 in November. Consensus was at 50.1. This is the first time in 19 months that factory activity in China contracted (pointing to higher chances for a recession). Zhengsheng Zhong, director of macroeconomic analysis at CEBN group (a subsidiary of Caixin), noted that the data “…showed external demand remained subdued due to trade frictions between China and the U.S., while domestic demand weakened more notably. It is increasingly likely that the Chinese economy may come under greater downward pressure.” Our take: China’s economy is decelerating, but is not on the edge of a recession (at least not yet).

There are three factor worth noting: the world’s second largest economy is cooling; in turn, there are elevated concerns about the impact of this on the rest of Asia and commodity producers (Australia, Brazil and Canada loom large here); and economic growth worries are becoming a greater point of attention for policymakers in Europe and the United States. The news led to Asian markets trading down on the first day of the year.

Is there another positive from December’s PMI data? The answer is that both Beijing and Washington may find greater incentive to resolve outstanding issues in their trade war. While China has decidedly felt the impact of U.S. tariffs, Washington also needs to keep the U.S. economy in the growth mode. HIS Markit chief economist Williamson noted of the PMI data, “…the survey also revealed signs of slower demand growth from customers, as well as rising concerns over the impact of tariffs. Just over two thirds of manufacturers reporting higher costs attributed to the rise to tariffs.”

For President Trump the successful resolution of the Sino-American trade war could give him a political boost for the looming 2020 presidential election as many of those affected by the trade war in the U.S., such as soy farmers and manufacturers in his base states, have been hurt by trade tensions. Xi also faces a potential rise in social unrest if the Chinese economy hits a noticeable slowdown. Consequently, the longer the trade war goes, the more challenging the economic and political landscape is for Presidents Trump and Xi Jinping. Although PMI data is a good indicator for the direction of the national and global economies, alone it does not determine continued economic expansion or recession. Nonetheless, it remains an important indicator, signaling that the recovery is increasingly fragile and policymakers, including central bankers, need to be watching closely.












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