September 25, 2020 – In a reversal from its July prediction, Morgan Stanley’s municipal research team now thinks federal stimulus will not be forthcoming in 2020, introducing down-side risk to municipal bonds.

The report said: Without further fiscal support, the broader macro outlook becomes murkier, introducing the possibility of near-term disappointment in economic data and rates volatility, historically a muni demand dampener.

In addition, negative headlines and potential rating downgrades may exert additional pressure on the asset class, increase volatility through interactions with Treasuries and other fixed income instruments, and ultimately, weaken investor demand.

The analysts noted that a stimulus bill is still possible, just no longer in the “base case” assumption. Nothing that Congress was still attempting to pass a stimulus bill, Morgan Stanley said “strong incentives remain to at least keep the door open to a deal in order to help incumbents from both parties p for re-election.“

The upcoming elections could provide municipal bonds its next catalyst, with a Democratic wave likely to trigger a fiscal expansion, steepen the yield curve but also increase the after-tax value of municipal bonds.

The bank recommends investors favor sectors that are positioned to fare well without Federal stimulus (airports, higher ed) and underweight state and local government credit.

Contact Lucia Diaz at LDiaz@buymuni.com.