Capturing Muni opportunities amid midterm battles | Insight Investment

Summary:

• The 2026 midterms could impact municipal credits through fiscal choices, tax measures and data center and other policies.
• Policies around recurring tax revenues, spending obligations and infrastructure cost allocations could determine the outcome.
• The most appealing issuer-by-issuer opportunities may offer near-term budget resilience and lower longer-term structural risk.

Federal gridlock may reduce threats to the municipal bonds’ tax advantages

Although control of both chambers remains uncertain, polling currently points to a potentially divided Congress. Investors often welcome such gridlock, viewing it as a source of policy stability.

For municipal investors, it potentially reduces the risk of changes to municipal bonds’ federal tax advantages, which had been a consideration of some deficit hawks and tax reformers during the construction of the 2025 budget reconciliation bill.

Reduced uncertainty over the tax exemption could help sustain retail demand and support municipal bonds, particularly as longer-dated AAA debt offers tax-equivalent yields competitive with high yield corporates for investors in the highest tax bracket (Figure 1).

Figure 1: Tax-equivalent yields provide market context¹

Unified state control can help address fiscal pressures

While federal gridlock can reduce the prospect of major policy changes, divided government at the state level can make it harder to address fiscal problems.

Research indicates divided government increases risks of delayed state budgets². Common party control of the governorship and legislature can reduce political obstacles to revenue and spending decisions.

This can become particularly important where states already face structural budget imbalances. Disagreement over how to close a budget gap can potentially delay structural adjustments and increase reliance on temporary measures. Unified control can offer a clearer path to difficult revenue or spending decisions. It will not guarantee sound budgets but can reduce execution risks.

A “trifecta” is when a single party controls the state governorship as well as the state senate and house/assembly. There are 14 potential states where midterms could make or break unified party control (Figure 2). Gaining it could make adjustments easier, losing it could increase the risk of gridlock.

Figure 2: States at risk of gaining trifectas may present opportunities³

Direct votes on tax policy could help or hinder fiscal dynamics

Voters will also decide 33 statewide tax-related measures this November, with implications for state and local government finances. These proposals deserve close attention because their fiscal effects can extend well beyond the next budget cycle.

Data center development in focus for revenue bonds

Local opposition to the data center buildout has increasingly emerged as a bipartisan issue (Figure 3).

Figure 3: Opposition to local data center construction has become a midterm hot topic⁶

New York issued an executive order in July pausing certain environmental permits for large-scale data centers pending further review.

For investors, the risk is that governments and utilities commit capital before securing associated revenues. Public opposition can delay or derail development, so revenue forecasts should distinguish between operating facilities, projects backed by contractual commitments and speculative proposals. We believe investors should also assess contractual commitments for enforceability and protection against cancellation.

Figure 4: The data center buildout is clashing with popular opposition⁷

In our view, the municipal and public utility credit implications depend less on the size of investment and more on development terms.

Data centers can require substantial supporting infrastructure spending and pressure electricity and water supplies. Public power and water systems may need to expand capacity. As with data centers, they can incur costs before realizing revenues, dependent on timing of construction and the nature of customer-assumed obligations.

In our view, better-positioned governments and utilities will seek to protect taxpayers and customers. This would mean avoiding letting fiscal benefits become absorbed by tax incentives or letting the public sector bear the cost of any unused infrastructure. The benefit may be more durable where data centers contribute to infrastructure investment and are responsible for costs if plans change.

This can leave minimum-payment commitments, dedicated tariffs, upfront contributions and termination provisions particularly important to our analysis, and we assess them against capital committed and the financial counterparty strength. Permitting delays, rent credits and tenant termination rights can weaken transactions and call into question demand assumptions. Utilities that phase spending and secure enforceable commitments will likely be best positioned⁸.

Conclusion: policy decisions may deliver municipal credit opportunities

The municipal market includes a wide range of issuers and bond structures (Figure 4). As a result, the same policy change can have materially different effects across credits. We believe understanding those differences requires analysis of the revenues supporting the bonds, the issuer's financial resources and the decisions available to its governing body.

Figure 5: The municipal bond market is highly fragmented⁹

Changes in political control, tax policy, and data center development can affect both fiscal flexibility and spending demands. We see the strongest investment case in issuers with the financial resources and most credible plans to manage these changes. Identifying them requires looking beyond election headlines to how policy decisions impact revenues, costs and the security supporting each bond.