Muni bonds got crushed. Instead of ushering in the lower long-bond interest rates that the Treasury secretary had oversold, the market went in the opposite direction. Record-level muni bond price volatility scared buyers away. For most issuers of state and local infrastructure bonds, that meant higher interest rates and thus higher annual debt service payments on new issues.
Meanwhile, the House Ways and Means Committee is continuing its work on the “big beautiful” tax bill that everybody expects to emerge by summer with a host of tax cuts and incentives, along with cost-shifting and reductions in intergovernmental grants that will clearly burden the operating budgets of states and municipalities. That fiscal brew inherently weakens the fixed-income markets overall and the bond rating scores of numerous muni issuers — no matter the eventual outcome of global tariff turmoil.
Given recent presidential tax threats to private universities and nonprofits over internal social policies, there’s conceivably a non-zero risk that partisan congressional gremlins could attach heavy-handed yet constitutional new strings to munis’ cherished tax exemption, such as a “tax bomb” section disqualifying bonds issued by “sanctuary” states and cities or for funding facilities that harbor disfavored asylum activities. That could become the muni market’s worst slippery slope of all time.
Lately the financial markets recovered a chunk once the president paused some of his tariff threats and softened his tough talk about replacing Federal Reserve Chair Jerome Powell after the White House lost the confidence of global investors. As a result, the mood in muni bond land has lightened a tad, but remains apprehensive. Despite this week's reductions and temporary pause, we really won’t know the ultimate outcome of tariff theatrics any time soon. Before we see a trade deal with China finalized, it’s likely that Congress will have decided whether — or for whom — to retain the tax exemption for municipal bonds. If there were ever a time to not let down one’s guard, this would be it.
Some have suggested that it would be more fiscally efficient to replace the federal income tax exemption with a long-term reimbursement of a fraction of interest on taxable muni bonds, but the issuer community has long opposed that idea on grounds that such a promise will eventually be broken. The current political regime has certainly given no reason to second-guess that prescient objection. Pennsylvania Avenue has been repaved with fiscal quicksand this year.
On that score, there is at least one reason to remain optimistic that Washington politicians will back away from the January gossip that the House tax writers could eliminate or trim back the federal tax exemption for interest on plain vanilla muni bonds. Some will claim success in the lobbying efforts by the states and municipal bond issuers, who blanketed Capitol Hill with constituents pointing to all the good things that come from muni bonds.
Their efforts do deserve some credit. But given the clearly adversarial posture of those in power, who are only too happy to shift costs from the federal government down to the states, the salvation of muni bonds will not likely come from just those valiant, well-organized efforts and congressional congeniality. There’s something more at work here.
For the main reason that muni bonds will likely remain tax-exempt, look to the mega-rich investors who contribute to political campaigns. Those are the people who benefit most from tax-exempt bonds, and they are the ones in charge now. So don’t kid yourself that it matters one whit to this regime whether New York or Texas issuers might pay interest of 5 percent tax-free versus 5.7 percent taxable for long-term muni bonds to build schools, housing and infrastructure. That’s not the point anymore. Today, it’s ultimately about providing lucrative tax shelters for the uber-rich. Politically, the local public purpose is now secondary.
Issuers’ Strategic Challenge
After the muni bond market fell out of bed last month, financial advisers and brokers were almost universally touting the great values available to investors in munis, suggesting that it’s a savvy time to lock in luscious yields pending the ultimate outcome of the tariff tempest. Those pitches would suggest that right now’s not the best of times to be selling new bonds.
For muni bond issuers, the challenge for now is whether to sit back and hope to outwait the recent market scare or to just get on with business as usual and sell their bonds at whatever interest rates the market demands. For those who can actually make that choice, there are two key issues: The first is whether Congress ultimately enacts a massive tax cut-driven federal deficit for the next decade and beyond. Endless large U.S. deficits would lock in a mounting onslaught of new Treasury bonds that could eventually drive interest rates higher everywhere. Looking longer term, that scenario suggests that it’s best to get debt financing out of the way before the bond vigilantes return in force.
The second, countervailing issue is whether the Oval Office tariff campaign throws the entire U.S. and possibly the global economy into a recession so deep that “flight to safety” buyers of Treasury bonds pull yields of tax-exempt paper lower as that tide goes out. That would potentially open a window to then sell high-quality muni bonds, but it would likely close quickly whenever the economy recovers. (It could also be the best foreseeable time to issue taxable pension obligation bonds.)
Of course, both scenarios could be true, in which case the real winners could be the lucky few who postpone bond issues until later this year or early 2026 on the chance that the White House shoots itself in the foot with its tariff theatrics and a recession then ensues. Savvy issuers could then score the best bond pricing for years to come. For public finance professionals, however, that’s a tough call: Not only does it require a crystal ball for predicting outcomes forthcoming from a mercurial presidency, plus agile market timing — it also runs the risk of putting the advocates of such a strategy in danger of being pilloried by political partisans who insist that the Oval Office has the economics all worked out. It requires proving a negative.
That’s called an asymmetric risk-reward profile. Given that public debt managers almost never get paid bonuses for brilliant bond sales — and the downside of getting it wrong is far more than just a brief reputational black eye in professional circles — I won’t hold my breath to see who’s daring enough to play the wait-and-see card this year. Most issuers will just have to bite the bullet and sell their bonds despite adverse and skittish demand. Meanwhile, watch out for any slippery-slope gremlins in the big tax bill.
Governing's opinion columns reflect the views of their authors and not necessarily those of Governing's editors or management. Nothing herein should be construed as investment or debt-issuance advice.
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