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The key question for municipal market investors heading into next week’s tight federal election is less about who wins and more about by how much.
Next year
Even with a divided government, most experts expect to see tax changes as provisions of the 2017
Changes to corporate and individual tax rates, the alternative minimum tax and state and local tax deduction cap will all impact demand for tax-exempt paper.
“Ultimately the composition of Congress is going to dictate how attractive munis are going to be,” said Jeff Schulze, head of economic and market strategy at ClearBridge Investments, during an Oct. 23 election webinar hosted by Franklin Templeton.
“The market is currently concerned that there may be a sweep with one party,” said Michael Pietronico, CEO, senior portfolio manager and credit analyst for Miller Tabak Asset Management.
“The bond market generally does not like one-party rule because there’s no real checks and balances on the spending side,” Pietronico said. “From our perspective, the balance of power being with one party is important to the bond market, and if the margin of victory is greater than expected that’s a problem, because that’s a mandate and they’ll get fiscal stimulus through.”
To offset risks, Pietronico said his firm is continuing its year-long strategy of “barbelling” its portfolios with one-year and 12- to 15-year paper. “Over the next two weeks those shorter duration assets, in particular the one-year paper, will continue to outperform until there’s some clarity on the election outcome,” he said, adding that the market is hoping to wake up the day after the election knowing “who won, and by how much.”
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The rise in rates since the Federal Reserve’s September decision and the recent “bearish” yield curves suggest the market could be “pricing in a Trump victory and perhaps even a clean sweep by the Republican party,” said Wells Fargo’s head of municipal strategy Vikram Rai in an Oct. 28 client call. The firm considers the most likely election outcomes to be either a Trump-led sweep of Congress or a Harris victory with a divided Congress.
A Republican sweep could “cause the curve to parallel shift up by 25 to 50 basis points, while a Trump presidency, even with a divided Congress, is likely to bear steepen the curve by about 25bp,” Rai said. “Both scenarios will be negative for fund flows which is likely to pressure municipal performance,” he said.
Regardless of who takes the White House, a divided government makes the prospect of fiscal expansion “more muted,” Rai said. “In the event of a Harris win, either with a divided Congress or unified one, we expect the market will price out expectations of a dramatic fiscal expansion.”
With seven days to go before the election, polls show ultracompetitive races for the White House and the House and a Republican edge for the Senate. UBS Wealth Management, in an
“The outcome is almost entirely dependent on voter turnout,” UBS said.
The market has considered what a red wave or blue wave would mean, but there’s a “high probability” that will not happen, according to the pundits, said Sheila May, director of Municipal Bond Research at GW&K Investment Management.
The general consensus is this will be a very close election, with pundits predicting a split Congress with a “thin majority” in each chamber, she said.
“If there was any deviation in away from that, any big surprise one way or the other, especially in the makeup of Congress, that could throw the market a little,” May said.
Narrow control would mean more clout for a group of bipartisan lawmakers from big-tax states like New York and California whose top priority is lifting or eliminating the $10,000 state and local tax deduction cap, said Kyle Pomerleau, senior fellow at the American Enterprise Institute, during an Oct. 23 election webinar hosted by Tax Analysts.
If the margins are slim, “the SALT Caucus becomes much more important,” Pomerleau said. “If the Republicans get a broad majority, they’re going to be less important.”
He added that it’s unlikely that the cap is totally eliminated given that “the math is so challenging already … it’s hard for me to imagine they’ll want to make the math even harder.”
If Democrats take the House, Rep. Richard Neal, D-Mass., long considered a muni supporter, would likely return as chair of the House Ways and Means Committee. Republican control of the Senate could put Sen. Mike Crapo, R-Idaho, atop the Senate Finance Committee. Crapo is
When Trump won in 2016, the market cheapened significantly, with the ten-year BVAL AAA cheapening by 75bp between Oct. 31 and Dec. 1, recalled Patrick Luby, senior municipal bonds strategist at CreditSights.
“‘Cautious’ will be the watchword” for portfolio managers around the election, Luby said.
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“If there’s extreme volatility coming out of the election and it is adverse to a portfolio manager’s performance, it could really hurt them in the fourth quarter and potentially for the year,” he said.
BofA noted in an Oct. 18 report that one-party control returns for the ICE BofA Muni Master Index, a broad measure of the tax-exempt, fixed-rate market, “have been weaker on a weighted average basis (9.88%) than divided control returns (28.00%).”
The strongest weighted average return was under a Republican-controlled Congress with a Democrat occupying the White House, BofA found. “The current makeup of control — Republican control of the House, Democrat control of the Senate and White House — is second strongest by return, with a weighted average total return of 24%.”
That compares to 19% for a Harris victory. Another 35% said a Harris victory would have a “somewhat positive” effect on the industry, with only 16% saying the same for a Trump win. Only 3% said that a Trump victory would carry no expected impact, while 16% said a Harris victory would have no expected impact.
Jessica Lerner contributed to this report.