Zeal for Cuts and Tariffs

Zeal for Cuts and Tariffs

The current zeal for cuts and tariffs is tantamount to a religious fervor. Yes, there are reasons offered for both policy choices. Cuts are being justified by the presence of rampant fraud and abuse. The consideration becomes cutting for the sake of properly sanctioned spending versus fraud induced spending and denying citizens required and necessary services. It has been hard to get a call back from Social Security even before all of this recent activity.

Tariffs hearken back to the newly favored 19th century. Almost all of the retailers that have discussed the topic of late have cautioned depending on the level of the tariff imposed that they will just need to be passed through to the end consumer. Most economists concur that tariffs will add to inflation in this scenario. We had some good news today at the 2.6% mark for inflation but the new tariffs have not begun yet. Next Tuesday has the potential to change everything.

The municipal market by all outward signs is functioning normally. Flows to the funds and to the ETFs have been positive. Volume is high but is being placed with relative ease. Rates have moderated somewhat in line with lower yields in the Treasury market. Is this the calm before the storm or are we demonstrating the meaning of the cliff risk?

The outline for the budget approach passed in the House this week. Preserving and extending the 2017 tax cuts has been a given. Paying for them with $2 trillion of spending cuts and other measures is hard to conceive. We will be cutting into “bone” so to speak. The details and which programs will be the most affected are awaiting further details. We do know with a relatively high degree of confidence that Medicaid will be a target. We must always keep in mind that one legislator’s cut is a valued program for someone else.

The reality is that Medicaid is a very important program for the states.? As I have mentioned before, Medicaid? spending is often the largest expenditure for states even in many instances surpassing amounts for education.? In order to appreciate what may be taking place, we may take a brief look at California. The executive budget has proposed MediCal (Medicaid in CA) spending of $188.1 billion for FY 2026. Approximately 15 million people are in the program in the state or almost 1 in 3 people. Among working adults 1 in 5 is covered by the program. It is estimated that half of all children are covered with this program.

Obviously, the cutting program should be done in surgical fashion to prevent mayhem. I am not convinced it will be done this way. The approach is more top down in practice. Adopting a block grant approach in this area will not cover all scenarios. States would not be able to easily “backfill” any cuts in the federal reimbursements. Yet, we do agree that fraud and abuse in the program should always be addressed.

There is a sliding scale for federal reimbursements for Medicaid with some states receiving more and some receiving less. Some states in the South have higher reimbursement levels. Hospitals that have higher levels of Medicaid in the Payor Mix will be much more vulnerable to the proposed cuts. We will need to see more details before taking more of a granular analytical approach.?

Congestion Pricing in New York City in the zone below 60th street to the Battery has a twofold purpose. One is to reduce congestion and to improve the flow of traffic and the other is to improve air quality. The $49 million collected in January and in subsequent months would be leveraged for a new municipal bond the proceeds of which would fund needed improvements to the system. Other than distaste for the program on the part of the administration, terminating the program would lead to many potentially negative consequences for the system. We await further developments by March 21.

Tax Exemption

Ending the tax exemption for municipal debt and obligations remains on the table. Those closest to the budget committee may provide some insight but no one knows the definitive outcome at this point. We have not heard too much from the Issuer community at this point. Industry groups are making their voices heard. All that may be said is that this threat does feel different from what transpired in the mid 1980s.

The Fed

Most pundits are predicting that the Fed will be on hold at its next meeting in March. Although there has been some positive news on inflation, the fiscal policies that are emerging are bound to change the landscape. If the economy slows appreciably, there is a chance for an easing later in the year. Yet, such an action is not a foregone conclusion at this point.

Equity Volatility

The recent volatility in equities is introducing some queasiness. The patina for the market leaders has faded a bit reflecting lower valuations. Yet, rates in the fixed income market have become a bit less attractive. Stability is gaining more of the spotlight and this trend should help the municipal market despite the many stresses extant.

Ending Wars

Ending the wars in swift fashion remains a goal. But the negotiations are quite complex and emotions are running high. Markets are subject to rapid change that may be quite unsettling.

John Hallacy

John Hallacy Consulting LLC

February 28, 2025