A US$153 billion pocket of the municipal-bond market that finances airports, housing agencies and nonprofits is trading like a tax on all but the wealthiest Americans will return to bite the middle class.

Barclays plc municipal strategists led by Mikhail Foux say that’s unlikely to happen. Such bonds “are extremely cheap”, according to Foux, who recommends investors snap them up at current levels.

At issue are Trump-era tax cuts set to expire next year that increased the exemptions on a tax for high-earning taxpayers known as the alternative minimum tax or AMT. Because interest income is taxable to those who fall under the AMT, muni bonds subject to the tax trade at yields higher than tax-exempt securities. That gap has widened amid concerns that a broader swath of investors will once again fall under the tax’s umbrella.

For bonds maturing in five to 10 years with AA credit ratings and issued by the same state and local government, the difference in yields between AMT and non-AMT bonds is close to all-time highs at about 0.75 percentage points, according to Barclays.

“The main reason is that people are concerned about what’s going to happen with the elections,” Foux said in an interview.

The Tax Cuts and Jobs Act or TCJA, which expires in 2025, reduced the number of filers subject to the AMT to 200,000 in 2018 from more than 5 million in 2017, according to the Bipartisan Policy Center, a Washington DC-based think tank. When the TCJA expires, 7.2 million taxpayers will be subject to the AMT starting in 2026, or about 4% of all taxpayers, according to the Congressional Budget Office, reducing demand for the debt.

A Trump victory in November and a “Red Wave” would likely result in the extension of the current AMT tax regime, a boon for bonds covered by the tax, Foux said. A “Blue Wave” would yield the same result, he added. Even with a divided Congress, lawmakers will face calls to maintain the status quo, he said.

“There will be quite a bit of pressure to sell the two sides to come up with at least some fix because AMT will affect mostly the middle class,” said Foux.

The AMT is a separate tax system that requires some taxpayers to calculate their tax liability twice - first, under ordinary income tax rules, then under the AMT - and pay whichever amount is highest, according to the Tax Foundation. The TCJA increased individual AMT exemption amounts as well as the level of income at which the exemption begins to phase out.

Many separately managed account managers may be avoiding AMT bonds, wary that their clients could soon be subject to the tax, Foux said. In addition, AMT spreads have widened because exchanged traded funds and most mutual funds can’t buy AMT bonds.

  - Bloomberg