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By Craig R. Brandon, CFACo-Director of Municipal Investments, Eaton Vance Management

Boston - Financial markets have a laser focus on the November 3 elections in the US — and perhaps none more so than municipal bond investors. We could even argue that the outlook for munis may be uniquely tied to the outcome of the presidential and congressional races. Let's consider the impact of different scenarios, starting with a continuation of the status quo.

Scenario 1: Trump wins, Republicans hold the Senate and Democrats keep the House

Assessment: Likely negative for muni bonds

  • In this scenario, we could potentially see more tax cuts, which would be negative as the tax exemption of munis becomes less valuable. Although on balance, 2017's Tax Cut and Jobs Act (TCJA) was actually a net benefit for muni bonds — particularly the cap on state and local taxes (SALT).
  • We expect that another round of federal aid for state and local governments could be less likely, and any package would be significantly smaller that the Coronavirus Aid, Relief, and Economic Security (CARES) Act of last March.
  • Any more pressure on the Affordable Care Act (ACA) would be a credit negative for the hospital sector, which is a large part of the muni market — especially among high yield issues.
  • This scenario could also be negative for credits like the New York City (NYC) Municipal Transit Authority (MTA) and NYC general obligation bonds. With so many working from home, large transit systems and the urban core areas have been struggling the most.

Special situations: Illinois, New Jersey, New York and California

  • President Trump and many Republican senators have referred to states like IL, NJ, NY and CA as having mismanaged their finances and pensions, and thus not deserving of a federal bailout that would reward their bad behavior.
  • We would agree that Illinois and New Jersey have indeed been mismanaged, but our annual State of the States update suggests that New York and California are in pretty good shape. Our analysis found that the other bottom-ranking states are actually Kentucky (48), Pennsylvania (47), Louisiana (44), West Virginia (43), Mississippi (42) and Kansas (41).
  • Nevertheless, many Republicans are strongly against any more aid to states and localities. They would rather open up the economy to get tax revenues flowing again, and they may be using these so-called blue states as examples, whether accurate or inaccurate. We suspect there could even be some partisan profiling of NY and CA to get back at leadership rivals in the Senate and House, respectively.
  • With a smaller probability of CARES 2.0 getting passed — or at least a package with more funding to state and local governments — there's a possibility that lawmakers in IL, NJ and NY could raise taxes. In fact, CA has already hinted at looking for revenue gains from top earners. Such actions would likely drive demand for munis in these states.

Bottom line: Maintaining the status quo — Trump presidency, Republican Senate and Democratic House of Representatives — could be a negative for municipal bonds.

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