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Municipal bonds are excellent choices for investors seeking a steady stream of tax free income. Usually, the interest income from munis is exempt from federal tax and may also not be taxable per state laws, making these especially attractive to investors in the high tax bracket looking to reduce their tax liability.

However, with the tax reform (or cuts) looking likely to be realized soon, after the Senate approved the biggest U.S. tax overhaul in three decades with a 51-49 vote in early December and House passed its own version in November, muni bonds came under pressure.

Both bills lower the corporate tax rate from 35% to 20%, but while the House cuts it instantly, the Senate postpones the cut till 2019. The House bill shrinks the current income tax brackets from seven to four: 12%, 25%, 35% and 39.6% while the Senate version keeps the current seven tax bracket: 10%, 12%, 22%, 24%, 32%, 35%, and lowers the top rate to 38.5% (read: Senate Passes Tax Bill: 5 ETFs to Buy Now).

If materialized, this reform will likely lower investors’ desire for a tax-shelter in munis in the coming days. Congress is planning to combine two tax bills that have the potential to cut as much as 30 to 40% of annual issuance in the $3.8 trillion municipal bond market, as per an article published on Financial Times.

As a result, states and municipalities are binging on debt issuances in the highest speed in more than a decade as they seek to raise capital before the Republican tax bill hits the market. The bout of issuances is so solid that the phase may turn out the biggest month of issuance in history, “surpassing December 1985 when almost $55 billion was sold ahead of the Reagan-era tax reform.” Notably, iShares National Muni Bond ETF (MUB - Free Report) is up 2.5% so far this year (as of Dec 5, 2017)

Other Deterrents in the Way of Muni Investing

Also, investors should note that though munis yield better than treasuries, these are less safer than government bonds. Now, with the Fed expected to hike rates faster in the future, yields in safer U.S. government bonds will likely be higher, thus crippling demand for munis – which will less likely be a tax haven in Trump residency. Plus, Trump has proposed to increase infrastructure spending. If this happens, munis will be forced to issue more bonds offering higher yields amid diminishing demand.

Is There Any Silver Lining?

However, all is not lost for these bonds. Trump has proposed to introduce a burst of stimulus by increasing the infrastructure spending package, easing regulations and tax cuts with the aim of accelerating economic growth and creating more jobs in the country. If things go according to Trump’s vision, we could see higher tax receipts and improved municipal finances.

Munis are comparatively more stable than equity or high yield bonds, making them great picks in any economic turbulence. And factors like North Korea-related nuke tension or Brexit can flare up volatility. Plus, high-yield muni bonds can win over high-yield corporate bonds for investors who are in search of higher current income.

If this was not enough, Bloomberg noted that analysts expect a solid retreat in new bond issuances in the first two months of 2018, as issuers managed to make several planned deals through this year. So, lower supplies may make munis shine again.

Bottom Line

No doubt, the space is currently downcast thanks to the likely tax reform. Still, there are some high-yield muni bond ETFs that offered relatively better returns than others in the last one month (as of Dec 5, 2017). These are (see all Municipal Bond ETFs here):

VanEck Vectors High-Yield Municipal Index ETF (HYD - Free Report) – Yields 4.33% and Up 0.8%

VanEck Vectors AMT-Free Long Municipal Index ETF (MLN - Free Report) – Yields 2.94% and Up 0.6%

VanEck Vectors CEF Municipal Income ETF (XMPT - Free Report) – Yields 4.89% and Up 0.5%

PowerShares Taxable Municipal Bond Portfolio (BAB - Free Report) – Yields 3.98% and Up 0.3%

SPDR Nuveen S&P High Yield Municipal Bond ETF (HYMB - Free Report) – Yields 3.78% and Up 0.3%

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