All eyes on House as potential GOP sweep poses threat to muni market
5 min read
Bloomberg
Municipal market participants Wednesday digesting former President Donald Trump’s victory and the GOP takeover of the Senate were keeping their eyes pinned on the House in hopes of avoiding a unified grip on power that would usher in major tax policy changes next year.
“If the Republicans retain the majority [in the House] then the municipal bond community must go into full gear,” said Charles Samuels, attorney at Mintz who is counsel to the National Association of Health & Educational Facilities Finance Authorities.
“New and old Republican members of the Congress need to understand at the individual state and district level the significance, impact and benefit of municipal bonds of all types,” Samuels said. “Anyone in the muni bond sector who doesn’t get energized in advocacy in the new political environment either should retire or look for a new job.”
The GOP scored decisive victories Tuesday night in the White House and the Senate, where as of Wednesday they had at least a 52-seat majority. The balance of power in the House remained up for grabs as of Wednesday. The Republicans currently hold 199 seats and the Democrats have 180. Fifty-six races remain to be called, with 218 being the number to reach for a majority. The final outcome is expected to be wrapped up in days.
“If the GOP wins the House, the specter of risk to the municipal bond tax-exemption will increase,” said Edwin Oswald, a tax partner at Orrick Herrington & Sutcliffe in Washington D.C.
Oswald recalled that early versions of the 2017 Tax Cuts and Jobs Act, which is considered Trump’s signature legislation, proposed the elimination of tax-exempt qualified private activity bonds.
“Given that the federal debt and annual deficit have ballooned since 2017, tax-exempt bonds and other items may once again be examined as a potential ‘pay-for’ revenue source to help pay for the extension of the 2017 tax law,” he said. “Given the election results, any hopeful prospects for the return of advance refunding bonds is now gone.”
Unified control of both chambers would likely “pave the way for expedited action” on extending, or making permanent, provisions of the TCJA, said Brett Bolton, vice president of federal legislative and regulatory policy at the Bond Dealers of America.
“This scenario comes with jeopardy for municipals as leadership will likely pursue the extension via the budget reconciliation process and will be looking for offsets to ensure the budget baseline is met,” Bolton said. “This is the same way the advance refundings were targeted back in 2017.”
Bolton noted that Trump on the campaign trail has proposed lowering the corporate rate to 15% for certain companies and lifting the state and local tax deduction cap. Both “are extremely expensive and raise the stakes for the need of additional offsets,” he said. “Munis are a top federal tax-expenditure, and we fully expect all expenditures to be looked at as possible pay-fors for this massive extension package.”
If Democrats take the House, Massachusetts Democrat Rep. Richard Neal is expected to take the helm of the powerful House Ways and Means Committee, where all tax policy originates.
On the Senate side, Idaho’s Sen. Mike Crapo is expected to chair the finance committee. Bolton notes that Crapo is “no stranger to fixed income.” He previously introduced legislation to raise the bank-qualified limit and “worked extensively on
Extending the TCJA provisions could add up to $5 trillion to the U.S. deficit, according to the Committee for a Responsible Federal Budget. A ballooning deficit could end up dinging muni credits, said John Hallacy, president of John Hallacy Consulting LLC.
“They’re going to work on cutting expenditures and we know from his previous stance that he’s supportive of the defense budget but when it comes to discretionary spending, that’s where the bulk of the cuts might come,” Hallacy said. “And some of that affects programs that go directly to states and localities,” he said. “I’m concerned about cutbacks of federal aid to states and localities and what that’s going to mean. Federal aid is a pretty big component of most state budgets.”
If Republicans take the House, it would harken back to 2016, when Republicans controlled Congress, said Emily Brock, federal liaison for the Government Finance Officers Association.
“Another similarity about that time is that they were facing tax reform, and we’re facing consent on provisions of tax reform going forward,” Brock said. She added that the Republican party has changed significantly since 2016 and in some ways is less unified. “You have to have agreement, especially when you’re looking at reconciliation as your tool,” Brock said.
“A divided Congress certainly slows things down a little bit. It sort of forces agreements across party lines in obvious ways,” she said. “One thing that we have tried to do in the issuer community cross country is highlight what projects are being built, so that when we go through our advocacy on the Hill during this discussion, we don’t talk about it as a nebulous thing and instead talk about it as physical, concrete assets that are a part of our community that make the livelihood in our community strong.”
Munis were selling off Wednesday morning, outperforming a U.S. Treasury rout.
An early morning read of Refinitiv MMD’s scale had yields cut eight to 15 basis points. UST yields have risen 11 to 20 basis points as of a 10:30 a.m. reading, with the largest losses out long.
The market is reacting to the potential higher tariffs and higher inflation, said Cooper Howard, a fixed-income strategist at Charles Schwab.
The market also faces the possibility of fewer Fed cuts than expected several days ago.
Howard still expects a 25-basis-point cut from the Fed on Thursday but would not be surprised if the Fed signals it will pause rate cuts and reiterating that rate cuts are data dependent.
With the Senate flipping to Republicans, that sets up more of Trump’s promises from the campaign trail to come to fruition, Howard said.
“At this point a lot is unknown,” he said.
