Decreased Supply Could Bode Well for Munis

Elizabeth Foos: While we continue to watch several credit stories in the muni market, it's been the market technicals making the largest impact as we enter 2018.

The debate over U.S. tax reform alone was enough to spur a record amount of activity for munis December. That impact is expected to be felt throughout the next year. As issuers rushed their deals to market ahead of the new tax bill's start on Jan. 1, muni issuance totaled nearly $70 billion in December; that's more than 3 times the amount of muni debt issued in December of 2016. With that, many are predicting a significant decrease in supply in 2018, which should bode well for current muni bond investors if demand holds up.

But certain aspects of the tax reform package could dampen that demand. Specifically, the cuts to the corporate tax rate could mean muni bonds are less attractive to large buyers, such as banks and insurance companies. Yet most market participants aren't predicting disaster just yet. That's because, among other things, the reform package also includes limits on tax deductions for certain individuals. Retail buyers in high-tax states such as California and New York could see their tax bills going up, making investment in muni bonds even more attractive.

Even with the lower supply in January, many muni funds still posted slightly negative total return amid market disruption, with funds in the intermediate- and long-term categories faring the worst.