Fixed-Income Insights
Muni Matters: Some Further Thoughts on the Midterms
Weighing the implications of the November 6 results for municipal bond investors.
The results of the 2018 U.S. midterm elections on November 6 had an immediate, slightly positive impact on the broad municipal bond market, with the benchmark Bloomberg Barclays Municipal Bond Index moving higher on November 7. But the results are unlikely to have much of a lasting influence on market performance, at least over the short term, because they were mostly anticipated.
With the Democrats taking control of the House of Representatives, the major issue of a possible second round of tax cuts, as recently floated by President Trump, was most likely eliminated. Lowering taxes would have reduced the benefit from the tax exemption of interest on municipal bonds, and likely would have pushed down prices of muni issues.
Other positive impacts upon municipal bonds were more sector- or credit-driven. For example, voters in three states, Utah, Nebraska and Idaho, passed ballot initiatives expanding Medicaid coverage to more people. This was a provision which had been initiated by the Affordable Care Act; many other states already took this action without ballot measures in order to attain increased Federal government support. Expanded Medicaid insurance coverage in those three states likely will reduce the unpaid expenses of hospitals for patients who do not have insurance, which could have a positive influence upon muni bonds in the healthcare sector.
In Illinois, a Democrat was voted governor, replacing a Republican. With one-party control assured as Democrats also hold the Illinois legislature, lawmakers should find it easier to successfully reach budget agreements—and enhance the state’s ability to increase revenues to improve its pension funding. This may have positive credit implications for Illinois’ municipal debt. There will be other state-level impacts from the net increase in Democratic governors which will need to be evaluated in states such as Wisconsin.
Another important development: There were many ballot initiatives approved that involved future municipal bond issuance in a number of states. These new issues are not imminent, but with many of these measures passing, it suggests that there is significant support for infrastructure spending.
Finally, with divided power in Washington, one area that has been highlighted for possible legislative compromise is infrastructure spending, with both President Trump and Democratic leaders signaling some willingness to work together. This potential bipartisan initiative will need to be tracked to see if it can happen, and if it does, whether it will lead to increased municipal bond issuance.
A Note about Risk: The value of an investment in fixed-income securities will change as interest rates fluctuate and in response to market movements. As interest rates fall, the prices of debt securities tend to rise. As rates rise, prices tend to fall. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The municipal bond market may be impacted by unfavorable legislative or political developments and adverse changes in the financial conditions of state and municipal issuers or the federal government in case it provides financial support to the municipality. Income from the municipal bonds held could be declared taxable because of changes in tax laws. Certain sectors of the municipal bond market have special risks that can affect them more significantly than the market as a whole. Because many municipal instruments are issued to finance similar projects, conditions in these industries can significantly affect an investment. Income from municipal bonds may be subject to the alternative minimum tax. Federal, state and local taxes may apply. High-yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Lower-rated investments may be subject to greater price volatility than higher-rated investments. There is a risk that a bond issued as tax-exempt may be reclassified by the IRS as taxable, creating taxable rather than tax-exempt income. Bonds may also be subject to other types of risk, such as call, credit, liquidity, interest-rate, and general market risks. Investments in Puerto Rico and other territories, commonwealths, and possessions may be affected by local, state, and regional factors. These may include, for example, economic or political developments, erosion of the tax base, and the possibility of credit problems.
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