Market reacts to Fed, SALT and public transit woes

As the market lurches from the effects of possible rate cuts to a less than stellar employment report, some industry leaders are dubious about negative forecasts for the near future.

"Many economists on the street are now penciling in a 50-basis point fund rate cut in September and November, with 25 point cuts thereafter," said Vikram Rai, fixed income strategist, head of municipal markets strategy, Wells Fargo (WFC).

"I am very dubious about this expectation, because if the Fed does that, they're effectively saying that they should have cut last week, and they're admitting the policy error."

The comments came during the weekly Wells Fargo (WFC) municipal strategy call and touched on several issues of key interest to the muni market. Rai has been with Wells Fargo (WFC) since September 2023 after leaving Citigroup (C/PN) last June.

Rai echoed other market leaders that blamed Monday's market plunge on fears hinging on the "Sahm Rule," that predicts a recession based on an unemployment rate that's at least half a percentage point higher than the 12-month low.

The rule was created by economist Claudia Sahm in 2019. Rai also remains dubious about the Sahm Rule and compared it to threats of recession related to the longest inverted yield curve in history.

"The inverted yield curve is supposed to be very good at forecasting recessions, and that was a dismal failure this time," said Rai.

The yield curve is referred to as inverted when the yield on two-year Treasury bonds is higher than ten-year bonds. The current inversion has been going on since July 2022, no recession has occurred, and the inversion briefly ended on Monday.

Last Thursday, the Senate put the kibosh on the Wyden-Smith tax bill that carried the possibility of adjusting the limitation on the tax deduction for state and local taxes ? an issue of interest to muni watchers.

The SALT deduction was capped at $10,000 as part of the Tax Cuts and Jobs Act in 2017. Critics of the policy claim the law is unfair for residents of high tax states while muni issuers say the cap infringes on their sovereign ability to levy future taxes.

Rai contends that while the states are experiencing higher collections, the federal government is subsidizing the payments.

"Many high tax blue states responded to the cap on SALT deductions by enacting something known as pass-through entity taxes," said Rai. "The federal government is facing a sizable revenue loss as a result of the cap on SALT deduction."

Pass-through entity taxes are now being used by 36 states and New York City as workarounds that allow entities to pay income taxes as a business as opposed to a partner or shareholder.

According to the Tax Foundation the cap is making money for the Feds. Their numbers indicate that uncapping the deduction would cost about $111.8 billion in 2024 and $114.3 billion in 2025, but the workarounds are taking a bite.

"We did find that state-level passthrough tax workarounds would reduce the revenue collection by about $211 billion over ten years moving forward compared to a policy where those workarounds were not permitted," said Garrett Watson, senior policy analyst and modeling manager, at the Tax Foundation.

Rai touched on several other New York-centric issues including the state's rising Medicare costs, asylum seeker complications, and the ongoing battle plan to install congestion pricing to prop up the Metropolitan Transportation Authority.