The results are in and what we see – with some races still being decided – is 52 seats now in the Senate for the Republicans and a 10-seat pickup in the House of Representatives, further extending the Republican majority.
What Do The Results Mean For Bonds?
With the Republican Senate, Senator Shelby of Alabama will most likely take over the Senate Banking Committee. He, along with Sen. Rand Paul of Kentucky, has been a vocal critic of Federal Reserve policy; and under the new Congressional regime, we can expect further pressure on the Fed from Congress in general. It’s hard to say whether this change impacts Federal Reserve Board independence, but at the margin it is certain to raise concern about whether the Fed can conduct its monetary policy deliberations with the same level of discourse as it is used to. In a world where perceptions matter, it is certain to “up the ante” when it comes to the Fed’s communicating its future policy. (We do not see the Fed raising short-term interest rates until the middle of next year or later).
We think that Republican gains also mean that there will be little, if any, discussion about bringing back Build America Bonds as a financing tool for municipalities (that would have been an uphill battle even if the Republican Party had not gained ground in the mid-term elections), which means that muni bond issuance should continue as now – with municipalities using the taxable bond market for certain issues but relying mostly on the tax-exempt market for usual issuance, plus the refundings expected in 2015 of older, higher-coupon bonds. One thing that we think DOES NOT CHANGE is the top marginal Federal tax rate of 39.6%. And even with the rally in the municipal bond market this year the top, most high grade long-maturity municipal bond is still yielding 3.05-3.10%, the same as the U.S. 30-Year bond. That means that longer municipal tax free bonds are still very cheap compared to other debt instruments and that this tax advantage needs to continue to be grabbed.
At the state-house level, governors who were taking tough approaches and addressing pension and other funding issues did well. And did not just follow party lines. They included Republican Governors Walker winning re-election in Wisconsin, Governor LePage winning in Maine, and Republican Bruce Rauner winning in Illinois, a state beset with very large pension issues and a $7 billion deficit. But Gina Raimondo, a Democrat, won in Rhode Island after serving as state treasurer, with a pragmatic approach to that state’s pension issues. What the state-house elections results suggest is that pension issues are going to be dealt with and “kicking the can down the road” fixes are in the past. This is a positive for general-obligation bonds at the state level in general but also at the local level, where similar discourse should take place.
Muni-Bond Elections
There were many different bond ballot issues in different states. By far the biggest was California’s approval of $7.5 billion in water bonds. This project had the support of Governor Brown (who was reelected) and is emblematic of the type of issue that voters, in general, approved this election. Needed infrastructure and a long-term approach to problems such as water (crucial in California) were approved. Also, transportation and school issues in general did well. More marginal projects, such as funding for new auditoriums, were voted down. In general though, we think that voters are somewhat more accommodative towards bond issuance than a year ago. We do think that the trend will continue to be a movement AWAY from services that operate on a subsidized service model and TOWARD a model that is market-based in terms of pricing services. This includes water, transportation, and infrastructure in general.
There are many themes to be played out as we approach the new Congress that will convene in January. We will keep readers informed on our thoughts.
John Mousseau, CFA, Executive Vice President & Director of Fixed Income