The muni market is not yet fully pricing in potential negative outcomes around tax reform, for which both candidates propose reforming tax rates and treatment of investment income, including muni interest, in a demand-negative fashion. Morgan Stanley summarizes the muni credit outcomes of competing reform proposals for healthcare, defense, and entitlement spending, among others. The tax treatment of munis would be at risk under either an Obama or Romney administration.
The political climate is such that 2012 campaign promises are potential near-term catalysts, not empty rhetoric. The electorate is deeply divided on deficit reduction and economic stimulus, and the “fiscal cliff” makes action on these issues imperative. Thus, resulting campaign proposals for tax, budget, and regulatory reform are key credit and market drivers for munis.
In aggregate, both policy sets are likely negative for munis’ tax value and a headwind for performance, though it is difficult to state if one set is definitively better than the other.
Election Outcomes, The Fiscal Cliff and Tax Value For Munis
However, we believe the muni market may need to reach yields equivalent to other credit options, at least temporarily, given that both proposals include the possibility of impairment of munis’ absolute or relative tax value.
Summary of Possible Tax Proposal Outcomes and Combinations
Based on the set of policies under consideration, we believe it’s a strong possibility that, at a minimum, a modification or elimination of the muni exemption is likely to find its way into a reform bill, at least temporarily, which suggests the market might price out the exemption out of caution.
Opposing Election Platforms Means Policy Uncertainty
Obama and Romney have opposing positions on several issues that may impact the municipal market. With recent polling data indicating the race is a close race, there is much uncertainty surrounding election outcomes and important policy issues.
Full Election Guide fro Muni bond holders: