The municipal bond market may have a lot more to worry about than just rising interest rates next year, which have already hurt it more than many other domestic fixed income markets.
There's the possibility that the new all-Republican Congress, with the blessing of President Donald Trump, will reduce or eliminate the tax-exempt status of municipal bond interest as part of a broader tax reform program.
President Barack Obama sought to limit the exemption to 28%, and Trump had expressed openness to a 10% limit early in his campaign, but in a mid-December meeting with a group mayors Trump reportedly said he would retain the tax exemption on the interest that municipal bonds pay investors.
Still, Christine Todd, president of Standish, an investment boutique owned by BNY Mellon, is worried. Writing in Barron's on Dec. 19, she noted, "The question of whether munis should be tax exempt arises when tax reform is taken up in Washington."
In addition, the tax reform agenda of Trump and Republican congressional leaders cuts personal income tax rates, which will lessen the value of the muni bonds' tax exemption.
Todd worries that since those proposed tax cuts would slash government revenues by several trillion dollars, the new administration could look to limit the muni bond tax exemption to make up some of those revenue losses.
But elimination of the muni tax exemption is seen as highly unlikely, according to analysts at BlackRock and other financial firms.
There is, however, uncertainty about the impact of Trump's plans to spend $1 trillion on infrastructure over 10 years on the municipal bond market. A plan that involves new, large issues of municipal bonds would likely damage the market by flooding it with more supply, but a plan involving tax credits for private companies, which has been suggested by Trump, may not necessarily be positive for munis.
