As the Trump administration slashes a slew of programs, investors are analyzing the potential impact on the municipal bond market.

“The political turbulence is making investing less predictable than usual across asset classes,” The Wall Street Journal noted recently.

Fortunately, initial evaluations of the muni market are promising. Elements that have contributed to the health of the bonds – indeed, the fundamental advantages of municipal bonds – are still in place.

Sectors that may be impacted

For example, hospitals could be impacted by cuts, but it’s unlikely that changes would negatively affect their bonds. Any reductions in Medicaid spending are expected to focus mostly on cost savings and not beneficiaries or access to care.

“While such actions would be negative for the sector, we believe hospitals could absorb any financial impact given strong 2024 performance and robust liquidity,” Lord Abbett said in a report.

States, which issue about 40% of municipal bonds, spend the largest portion of their budgets on Medicaid. Though analysts say political pushback makes it unlikely Medicaid funding would be significantly cut, any changes “would likely be phased in gradually, allowing states time to adjust their programs,” according to the firm.

The report underscores a key benefit of municipal bonds: “States have various levers they can pull in the face of federal cuts, including increasing their share of spending, reducing enrollment or benefits, or lowering the rates paid to healthcare providers.”

The power and flexibility of state and local governments to adjust their revenue is well-known to municipal bond investors – it’s what helps them sleep soundly at night.

Housing credits generally ‘very strong’

In the housing sector, state and local authorities “generally have very strong credit quality due to strong underwriting standards and loan portfolios,” Lord Abbett said. Support for affordable housing makes reductions in important federal housing programs unlikely. Though there could be some impact on a small number of issuers, “we do not believe it will have a meaningful effect on the broader municipal market.”

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Although airports may face federal cuts for capital expenditures, gaps could be filled by issuing municipal bonds – the primary funding tool for large airports. “Furthermore, the credit quality of airports remains robust, characterized by strong liquidity and revenues that are not tied to passenger volume,” Lord Abbett said.

The report also covered higher education. The balance sheets of many universities have improved since the pandemic and their revenue sources are varied, which could help make up for federal funding reductions.

Further, there have been discussions in Congress on whether to increase the excise tax on net investment, from 1.4% to as high as 21%, Lord Abbett reported, and possibly expand the tax to cover more institutions. Most of the impact, the firm says, would be borne by “only the strongest institutions,” which have significant resources. Their financial aid, scholarships, research or the general operating budget may be cut back to make up for a decrease in revenue.

Drama-free munis

Wild swings in the stock market, aggressive efforts to decimate longstanding federal programs and the imposition of punitive tariffs are, unsurprisingly, unnerving investors, so any attempt to predict the future would be foolhardy (“Amid the Exemption Debate, Muni Investors Keep Reaping”).

Right now, however, the municipal market is doing what it’s always done. It is serving as a drama-free counterweight, where investors peacefully keep their tax-free income flowing.