Bond bites: Ideas and insights in under three minutes

The Federal Reserve or Fed finally began its easing cycle by cutting interest rates by 50 basis points at its September 18th meeting. As a result, investors have been asking us what they should be doing with municipal bonds in this environment. To answer that, I'd like to focus on four points. Point one: Rates are attractive. It may be time to lock in. Bonds are back to acting like bonds and this includes municipal bonds.

For a while, income was missing from fixed income because rates were so low, but today's starting yields are more attractive, providing higher income levels and lowering the correlation between bonds and equities. More of your bond returns now come from income, not just capital appreciation. Municipal bonds are higher than they've been in the past several years, following two years of unprecedented interest rate hikes by the Fed.

The good news is that the Fed has finally begun to cut interest rates. The great news is we are only in the early innings of the easing cycle. The muni market has recently seen investors wading back into long term, actively managed funds in order to lock in historically high interest rates. And we believe there is still time to do so.

Point two:  Tax exemption is key -- It's not what you make, but what you keep. Investors are increasingly looking toward the upcoming presidential election and wondering how it will affect their holdings. We've got news for you -- no matter who wins the race, your taxes are not likely to go down. That makes municipal bonds so important for high income earners. If an investor earns 4% in the tax-exempt municipal bond fund, that same investor would need to earn 6.75% in a taxable fixed income investment to take home the same amount of money after taxes if they are in the highest Federal tax bracket.

If that same investor earned 5% in the municipal bond fund, they are looking at almost 8.5% needed, and that doesn't account for potential state taxes. Point three: Credits are strong. We've got the income portion covered, but what about capital preservation? Municipal bonds have a long history of low defaults compared to corporate bonds, because they fund essential American services.*  Credits are currently very strong, and we are seeing two credit rating upgrades for each credit rating downgrade.** .

This is on the heels of nearly 4 to 1 upgrade to downgrade ratio in 2023. Additionally, all states are investment grade, with 48 of the 50 having credit ratings of double AA or higher.*** . This is due to strong balance sheets with rainy day balances expected to end higher than the previous fiscal year. Over the past few years, various federal stimulus measures like the American Rescue Plan Act and the Inflation Reduction Act among others, have filled states’  coffers with billions of dollars.

Plus, state and local taxing bodies have collected higher revenues than in pre-pandemic years. What's notable is that state and local authorities have been fiscally responsible with the influx of cash, beefing up reserve funds instead of spending the money frivolously or on new programs that would be difficult to maintain without a continuous flow of federal dollars. This also provides states and many municipalities a nice cushion in the event that the economy takes a turn for the worst. Meaning, most municipal bonds have the ability to continue to paying principal and interest to bondholders in the event of an economic downturn.

Finally, that leads nicely into Point 4: Our research capabilities.  At Invesco. we take great pride in our dedicated municipal credit research team. All bonds purchased for our portfolios are internally rated by one of the team's 24 credit research analysts. This is incredibly important as there are close to 1 million individual CUSIPs outstanding in the market. 1 million! A strong and deep credit research staff can make investing in the space worthwhile. Our team has nearly an average of 20 years of investment experience.

They complete thorough analysis of current opportunities in the municipal universe, as well as ongoing surveillance of those issuers held to identify opportunities or deterioration in the credit quality. They also conduct periodic site visits with management on each non rated and high yield project that is purchased for a fund. These four points are just some of the reasons we believe now could be an attractive time to add tax exempt municipal bonds to your portfolio.

Important Information:

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.

The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions.

Fixed income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating. Municipal securities are subject to the risk that legislative or economic conditions could affect an issuer’s ability to make payments of principal and/ or interest. The fund is subject to certain other risks. Please see the current prospectus for more information regarding the risks associated with an investment in the fund.

A basis point is one-hundredth of a percentage point. 

A credit rating is an assessment provided by a nationally recognized statistical rating organization (NRSRO) of the creditworthiness of an issuer with respect to debt obligations, including specific securities, money market instruments or other debts. Ratings are measured on a scale that generally ranges from AAA (highest) to D (lowest); ratings are subject to change without notice. NR indicates the debtor was not rated and should not be interpreted as indicating low quality.

For more information on rating methodologies, please visit the following NRSRO websites: www.standardandpoors.com and select 'Understanding Credit Ratings' under Rating Resources 'About Ratings' on the homepage.; https://ratings.moodys.io/ratings and select 'Understanding Ratings' on the homepage.; www.fitchratings.com and select 'Ratings Definitions Criteria' under 'Resources' on the homepage. Then select 'Rating Definitions' under 'Resources' on the 'Contents' menu.

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Invesco Distributors Inc.    10/24     NA3876210

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00:00:02:32 - 00:00:22:06

Unknown

We're finally at a point where the fed looks ready to start cutting interest rates, and a lot of investors are asking us, what should we be doing in this environment? To answer that, we first need to consider why the fed is cutting. In our view, it's not because they have to. It's because they can. That's an important distinction.

00:00:22:11 - 00:00:43:01

Unknown

Inflation is slowing. The labor market is cooling, and the economy seems to be finding its balance. But we don't see this tipping into a hard or prolonged recession. We expect the fed will likely cut rates gradually over the next year to 18 months. This should bring rates back to a less restrictive, more neutral stance that we believe will support both the economy and the bond market.

00:00:43:06 - 00:01:05:30

Unknown

As we enter this likely rate cutting cycle, now is a great time for investors to reassess their portfolios. Here are three things to consider. Number one, money markets T-bills and CDs have been great investments over the past few years and investors were wise to hold them. But as the fed starts cutting rates, it may be time to move on from renting those yields to locking them in for the longer term.

00:01:05:35 - 00:01:27:32

Unknown

By adding a bit of high quality credit, investors can secure more attractive yields. Even with an inverted yield curve. This approach offers the potential for better returns compared to staying in short term cash vehicles. And history is on your side with this approach. Bonds have historically outperformed cash and provided returns in excess of inflation, while cash has often struggle to keep pace.

00:01:27:37 - 00:01:50:26

Unknown

Second, bonds are back to acting like bonds. For a while, income was missing from fixed income because rates were so low, leading some to question the viability of the traditional 60/40 portfolio. But today's starting yields are more attractive, providing higher income levels and lowering the correlation between bonds and equities. More of your bond returns now come from income, not just capital appreciation.

00:01:50:30 - 00:02:13:23

Unknown

Third and last. You don't have to take on a lot of risk to see positive outcomes in the bond market. Investment grade credit, higher quality high yield bonds and top segments of the securitized market represent a sweet spot. If the economy has a soft landing, investors could benefit from an attractive income stream, potential capital appreciation from duration and lower volatility as the fed cuts.

00:02:13:28 - 00:02:34:48

Unknown

And if we do see a hard recession, the Fed's ability to cut rates faster should benefit high quality bonds compared to equities and riskier fixed income segments. Institutional investors have already been moving aggressively into intermediate investment grade bonds over the past year. And it's not too late to get in. With the fed just beginning to cut rates on their journey here.

00:02:34:57 - 00:02:46:35

Unknown

There's a wall of cash and in motion, as both retail and institutional investors continue moving into the investment grade bond space, which we believe will keep supporting the market.

00:03:27:00 - 00:03:49:00