The outlook for public finances in 2022 in 6 themes
The past year has brought an unusual crop of surprises to the state and local government financial community. But even without a 20/20 forecast, there are several macroeconomic trends currently underway that should make it easier for well-informed policymakers, professional staff and financial service providers to make better decisions for the benefit of the public sector as a whole. Here are six of the main themes to keep in mind, with the caveat that a global mutation of the coronavirus beyond pharmaceutical solutions – a mutation requiring a new round of economic blockages – would be entirely ruled out:
1. Inflation will remain a monetary reality. Most of the problems in industrial and logistics supply chains are expected to be addressed in the coming year, and searing commodity prices are cooling down, but that will not end inflation.
Three factors almost guarantee an inflation rate that ends in 2022 well above the Federal Reserve’s long-term 2% target: First, house prices and rental rates have failed. still made their way into statistics, and that alone will lead to higher employee salary demands and expectations; Until interest rates rise enough to cool the housing market, housing costs will drive inflation upward. Second, salaries, including those of civil servants, will have to adjust upwards to cover the recent surge in the CPI, and these costs of doing business will not be transitory. Finally, the elephant in the room is the massive increase in money supply that the Fed’s monetary policies of the past two years have left with us.
What macroeconomists call aggregate demand ultimately tracks the money supply when unemployment rates are low. Here is a chart showing the unprecedented surge in “M2” – cash and sight deposits such as checking accounts, as well as term deposits such as savings accounts, money market funds, and CDs. – in billions of dollars during the pandemic, especially in 2020:
But persistent inflation doesn’t mean we have to go back to the stagflation debacle of the 1970s. If the United States can enter 2023 with annualized price increases falling back to around 4%, our economy is capable of recovering eventually. to a tolerable and somewhat lower long-term trend. The M2 “pig” described above will ultimately work on its own thanks to the Fed’s COVID-19 quantitative easing “python”. Prices and possibly wages will likely reset another 10% higher by then, but thereafter we should see some compensation then sayinflationary forces, including cost-cutting technological innovations, the new frugality of a retiring fixed-income baby boom generation, and a plentiful supply of lower-cost labor overseas .
However, even an inflation rate as low as 4% next December would likely be enough to trigger an embryonic, multi-year spiral in wages and prices, creating a new trio of trends in labor, money and bond markets. , which will likely have an impact on state and local finances.
2. Payroll budgets will increase. Each public employer has its own unique workforce characteristics, local labor markets and history, so it is unwise to generalize. But policymakers who think they can weigh down labor costs are sticking their heads in the sand. Unless a new variant of COVID-19 sweeps across the country and forces another lockdown, it’s hard to predict a plentiful and oversupply labor supply in 2022; the continued labor shortage is much more likely.
Employee unions will not be gullible about inflation on the wage side, and in contract negotiations their leaders would be abandoned if they did not push for “COLA plus X” provisions. Where this could become particularly interesting in 2022 is in the cost of housing for public officials. My new term for this is “COHAs” – the cost of housing allowances. It seems almost inevitable that high-cost or short-housing municipalities will have to offer rent relief to help their new employees afford to live locally or risk losing them.
3. Higher interest rates will provide cash management opportunities. Financial media has focused on the “taper” of central bank bond purchases – the end of quantitative easing in the COVID-19 era. Less mention is made outside of trade channels of the revised outlook for short-term interest rates, which have risen significantly as I announced last October. Again, barring a global mutant COVID-19 monster, the Fed must now “normalize” its short-term rates by cautiously and cautiously raising overnight money market rates closer to 1% of here the end of the year, and probably even higher. Finally, money market rates must move closer to the rate of inflation.
For public treasurers and cash managers, the good news is that they will finally be able to report positive returns on their short-term investments. The bad news is that public portfolio managers looking at longer maturities beyond 2023 are likely to come to regret it – and someone will, as happens in almost every rate cycle.
4. Higher municipal bond yields are coming. Current bond yields no longer make sense; I can’t reconcile the inflation elephant in the room with the lowest municipal bond interest rates in decades:
Public officials should rush to the market to get their infrastructure and other funding as soon as possible. The risk of higher bond yields now clearly outweighs the possibility of cutting costs anytime before the next recession. Historically, most long-cycle expansions require a hike in interest rates before settling into a lower but sustainable growth rate. For now at least – unless we hit an “exogenous” factor like war or a much worse mutant virus – a recession most likely looks several years away from the boom cycle. This bodes well for higher municipal bond yields over the next two years.
5. Public pensions will face a pinch of COLA. Pension fund trustees will inevitably spend time on the agenda of training sessions with their actuaries on their long-term inflation assumptions, and it’s a safe bet that most pension actuaries and representatives of employees will do their best to fend off the inflation hawks on their boards. The board’s pension jokes will abound on speakers’ ill-chosen references to “transient” inflation; I foresee an increasing use of the disguised surrogate term “non-persistent” to describe 2022 inflation rates in pension circles.
But the reality is that many plans that include cost of living increases in retiree pensions will experience an increase in their unfunded pension liabilities as the 2022 COLAs exceed their actuarial assumptions. Of course, the salary base will eventually increase to catch up, so that pension contribution rates as a percentage of salary may remain stable.
6. Fiscal uncertainty will continue to prevail in Washington. The Senate’s deadlock on the Democrats’ plan to rebuild better portends a year of political obstacles for any major tax measure that would materially benefit states and localities beyond those already enacted in the COVID-19 2020 relief plans and 2021.
If Senator Joe Manchin’s objections to inflation-inducing federal spending were purely fiscal, this problem could be solved by party progressives by introducing more impactful “paid” income boards into their platform, to pluck the richest geese. . These could include reforms to the increase in inheritance tax, a stricter minimum tax rate on the income of millionaires, a cap on the personal income deduction of private companies known as QBID , a significant surtax on corporate share buybacks, a reform of the deferred interest preference granted to investment fund managers and the elimination of oil extraction depletion allowances.
The problem for state and local lawyers is that they don’t want to make lifelong enemies of lobbyists for the one percent who buy municipal bonds, and professional associations are keen to uphold their bipartisan reputation. Perhaps the progressive camp in Congress will pivot and play a balancing game with populist tax proposals that enjoy broad voter support. Even so, public finance supporters operating behind the scenes will still only be wagging their tails on any revised federal tax and spending package.
The bottom line for public finances: For most state and local authorities, 2022 will hopefully be the most ‘normal’ year they have seen since 2019, so awareness and preparedness will help navigate this. these crossed macro-currents.
GoverningOpinion columns reflect the opinions of their authors and not necessarily those of Governingthe editors or the management of. Nothing herein should be taken as investment advice.