Special Edition: The Midterms and Your Municipal Portfolio
Where the Market Stands
Munis extended their October rally through the final week of the month, capping the strongest October for the asset class since at least 1980 and the strongest month since November 2023, per the Bloomberg Municipal Bond Index. Our read is that munis simply got too cheap in September, and those prices were not sustainable. Paper yielding more than 5% on the longer end of the curve equates to a taxable-equivalent yield of roughly 8.33% for an investor in a 40% bracket, a level of income that deserves a look.
Yields fell steadily across the curve this week, with the 10-year benchmark down roughly ~14 basis points. As we have reported, yields have been coming back in over the past ten trading days.
The rally was supported by lighter supply heading into the Fed’s October 28 meeting and continued cash deployment by investors. The meeting itself was a key focus mid-week and contributed to a quieter new-issue calendar, and the market reacted positively. The turn began in the second week of October and has continued into November so far.
Last week, we said we remained buyers and expected yields to grind lower over the next couple of months. The past ten trading days have gone that way, and Tuesday’s election results now add a new set of considerations.
The Election Result
Democrats won both chambers of Congress in Tuesday’s midterms, taking 54 Senate seats and flipping the House by large margins. No key muni champions in the House were lost in the process. Below is how we see the implications for munis.
What It Means for Munis
Tax Exemption: Reduced Near-Term Risk
The muni tax exemption has been under sustained pressure, most visibly when last year’s One Big Beautiful Bill briefly threatened to curtail it. With Democrats now controlling both chambers, the probability of further legislative attacks on the exemption is significantly reduced. That is broadly constructive for muni valuations, particularly long-dated paper, which repriced sharply during that scare. With more than 30 years in the bond business, we have seen this topic come up in every political year, and we do not feel, and have never felt, that the tax exemption will be removed from munis.
Muni-Friendly Legislative Priorities
Municipal lobbyists are eyeing the incoming 120th Congress, convening in January 2027, as an opportunity to advance perennial priorities, including restoring tax-exempt advance refunding and expanding private activity bond capacity, likely via the surface transportation bill. Rep. Richard Neal (D-MA), a strong muni advocate, is positioned to reclaim the chairmanship of the powerful House Ways and Means Committee. Should advance refunding be restored, expect many more calls to be exercised in your portfolio over the next few years.
Gridlock and the Fiscal Trajectory
With Trump in the White House and Democrats controlling Congress, Washington enters a period of divided government. We remain skeptical that gridlock will meaningfully address the federal deficit, as it has historically failed to. For munis specifically, gridlock limits the risk of sweeping tax reform but could also constrain federal infrastructure spending that would otherwise support issuer credit quality.
State and Local Revenue: Ballot Measures
Voters in 16 states weighed income and property tax measures on Tuesday. Several proposals aimed at capping taxes could constrain state and local revenue, with potential credit implications for issuers in those states. At least $84 billion in bond referendums were on ballots nationally, exceeding the $81 billion considered in the 2024 presidential election cycle, and approved measures would add to future muni supply. We do not see this as a negative and suspect the supply will be absorbed with ease. Should the total reach $100 billion, absorption could become a headwind. We do not expect that, but it is something to keep an eye on.
Housing and Bipartisan Overlap
Housing affordability tax cuts are expected to be an early area of bipartisan negotiation in the new Congress, which could benefit housing-related muni issuers. We will monitor this closely, as it could prove a positive for housing paper.
Net Takeaway
Tuesday’s result reduces the most acute near-term threat to the muni tax exemption and brings pro-muni legislators into key committee leadership roles, both supportive for the asset class. The offsets are continued fiscal uncertainty at the federal level and potential revenue pressure on state and local issuers from ballot-driven tax caps.
As muni investors, we suspect federal income taxes will not be reduced, and state income taxes could rise, including the possibility of new state taxes in places like Texas. We know that is a long shot, but right now nothing is off the table when it comes to taxes.
There are risks to this view. Divided government could slow the federal support described above, ballot-driven tax caps could pressure issuers in affected states, and more new supply than we expect could weigh on pricing. Any of these could push muni yields higher, and bond prices would fall along with them.
We are watching three things most closely: how the new Congress handles the surface transportation bill and advance refunding, how the state tax-cap measures settle, and whether bond referendum totals approach that $100 billion mark. We will keep you posted.
Where the Tailwinds Point
We feel the following sectors could benefit from the change.
Housing. We think housing paper carries the most direct legislative tailwind. Housing incentives are likely to be identified with the broader agenda centered on affordability.
Healthcare. As we have seen in history, healthcare paper typically benefits from Democratic priorities, but it carries a more nuanced risk profile than housing paper.
Transportation. We suspect this sector will see a meaningful tailwind. The $500 billion surface transportation bill is up for renewal, and Democrats are expected to push for higher non-defense spending within it, a key vehicle for restoring tax-exempt advance refunding, as noted above.
Education. Education structures should receive support but are not identified as a primary Democratic legislative priority in the near term. Public hospitals, schools, and facility upgrades could also see a tailwind, in our opinion.
Recommendations
Look at the longer end while exemption risk is lower
Longer-dated paper repriced sharply during the exemption scare, and it is the part of the curve that stands to benefit most as that risk recedes. With paper above 5% equating to roughly 8.33% on a taxable-equivalent basis for a 40% bracket, and with federal income taxes unlikely to fall in our view, tax-exempt income deserves attention.
Favor sectors with a policy tailwind, and stay selective within them
We see housing with the most direct tailwind and transportation with a meaningful one, while healthcare and education are supported but carry more nuanced risk. Selection within each sector still matters.
Look closely at call dates on every offering
If advance refunding is restored, expect many more calls over the next few years. Check call protection on each bond you consider, and think through what you would reinvest into if a bond you hold is called.
Review your exposure in states weighing tax caps
Voters in 16 states considered income and property tax measures, and caps could constrain revenue for issuers there. We would welcome a conversation about your holdings in those states. Reach out if you would like to discuss any of this in the context of your portfolio.
Let’s Talk
If you would like to discuss any of the above in the context of your portfolio, reach out. This market environment rewards preparation — and that is exactly what we are here to help with.
