Keep Calm and Own Munis
- The new tax law is unlikely to spell trouble for the municipal bond market.
- The income and diversification potential of munis remains compelling.
- In-state bonds may shine brighter for residents of California, New York and other high tax states.
The Storm Before the Calm?
What a difference a month makes. Late last year, municipal bond prices declined as new issues flooded the market. Uncertainty around tax reform and the potential for the municipal exemption to be scaled back for non-profit bond issuers such as universities and hospitals had unsettled the market.
Early versions of tax reform legislation proposed wide-ranging changes. Some of the measures considered could have greatly affected both supply (in terms of which entities could issue tax-exempt bonds) and demand — due to changes in marginal tax rates for investors.
Fast forward to the present — municipal bonds have recovered some lost ground, and markets have mostly been calmer. As anticipated, tax reform has reduced various federal tax rates, especially for corporations. The most significant potential changes to the types of issuers that can benefit from the exemption did not make it into the final bill.
Critically, the tax exemption of interest earned from municipal bonds was untouched. Even so, one question looms large: Has tax reform changed the big picture for investors in municipals? On balance, I don’t believe so.
Overall, my near-term outlook has not radically changed in the wake of the Tax Cuts and Jobs Act. For tax-aware investors, the bottom line is that higher quality municipals remain a compelling option for core fixed income allocations in 2018. Here’s why: