Municipals Brace for Tariff Policy Exposure; Markets Rally Following Treasurys in Flight to Quality

While the stock market immediately sold off in response to President Donald Trump’s tariff policy announcement on April 2, the municipal market rallied mid-speech, benefiting from the Treasury market flight to quality, according to market sources.

The flight to quality is typically a response when there is extreme market dislocation and a “risk-off” mode in the equity market, noted Chris Brigati, chief investment officer and managing director at SWBC Investments. MMD benchmark rates are lower by 6 bps-12 bps across the curve since “Liberation Day.”

“The belly of the curve is experiencing the most aggressive moves, and it’s lighter on the front end,” said Brigati. “The Munis-Treasury ratio is attractive relative to what we’ve seen for quite some time.”

The M/T ratio is close to 76% for the 10-year, which the market experienced earlier in the week, while the 30-year ratio is roughly 92%. The last time ratios were this attractive was October 2023, according to Brigati.

Munis are attractive compared with corporate bonds for investors in the 22% tax bracket in the current environment, according to Cooper Howard, director of fixed income strategy at Schwab Center for Financial Research.

“We’ve seen spreads increase, just over the past few days. They’ve also increased a little bit for lower-rated issuers,” said Howard. “I think it’s more appropriate to take a defensive stance in this environment. That means focusing on higher-rated issuers and sticking to a below benchmark duration.”

Some of these dynamics are cyclical, according to Brigati. As the April 15 Tax Day approaches, municipal bonds generally get cheaper. Munis have reached more attractive ratios as a result of the recent market move.

Sources say it is premature to speculate on what impact it will have on deals pricing next week. The City of New York and Bon Secours Mercy Health are approaching the market in the two biggest bond offerings next week.

“The rally happened so fast and intense that there wasn’t too much change on the new issue front this week,” said a source. “We might see things develop next week in the new issue market if the rally holds. This has the feel of a market that has been battered too many times to really trust a good day.”

No corporate borrowers have issued in the past two days, and IPO deals are getting pulled back, according to Howard. “It wouldn’t be too surprising if deals in the muni market get pulled too.”

Municipal Tariff Exposure

While municipal bonds could be largely insulated from the trade war as a domestic product and backed by local revenue sources, tariffs might affect sectors such as transportation, infrastructure and project finance. Port authorities and toll roads dependent on commercial traffic, in particular, could take the first blow, market sources told Octus, formerly Reorg.

“Ports with long-term contracts with terminal operators, favorable minimum annual guarantees and CPI escalators may be better positioned to absorb volume and revenue volatility,” said Mohammed Murad, head of municipal credit research at PT Asset Management.

More broadly speaking, “exposure will largely translate into higher project costs, in addition to inflationary pressures,” said Murad. It could be a factor in the acceleration of primary supply of both high-yield and investment-grade credits, he added.

This means sectors such as infrastructure and industrials, reliant on steel production in China, could face headwinds. Tariffs will make it more expensive for construction projects to get done, which are top of mind for many issuers.

Sources are expecting a drop in new multifamily housing projects that will get built and financed. The cost to construct these projects is increasing, and it is “hard to make the math work,” according to a source. California’s workforce housing corner of the market is already feeling the scarcity of new construction projects.

“States with economies reliant on exports, such as energy for Texas, technology and agriculture for California, and manufacturing and agriculture for the Midwest, could face revenue declines if tariffs slow trade,” said Alice Cheng, director and municipal credit analyst at Janney Montgomery Scott. “A reduction in consumer spending due to high prices may pressure sales and income tax collections.”

Healthcare is another sector market participants are scrutinizing and expect will have tariff exposure through medical supplies and devices, Cheng added. Pharmaceuticals could pressure public hospital systems and Medicaid budgets, which are already at risk in the latest policy moves.

“Hospitals are still very reliant on overseas trade, even China, for a lot of commodity medical supplies [such as] bandages and drapes,” added a source.

Universities with large international student populations could face revenue risks if trade tensions lead to declining enrollment and visa restrictions, added Cheng. The latest movement on Capitol Hill introduced increased taxes on university endowments, warned Howard.

Many investors are keeping an eye on future negotiations and are unsure if the current tariffs were just used as an aggressive negotiating tactic on the global stage. Nonetheless, it will take some time for tariffs to filter through supply chains and into the municipal market while participants await clarity with regard to how other countries respond to tariff news, said Murad.