The Bloomberg Municipal Bond Index is currently yielding 3.85%, or a 6.5% tax-equivalent yield.1
We expect muni performance to improve during the summer months due to stronger market technicals.
Investment grade and high yield muni bonds have historically had a low correlation with US stocks, corporate bonds, and Treasuries.
Municipal bond yields have become attractive to US taxpayers, in our view. The Bloomberg Municipal Bond Index is yielding 3.85%, or a 6.5% tax-equivalent yield.1 The Bloomberg High Yield Municipal Bond Index is yielding 5.59%, or a 9.4% tax-equivalent yield.2
Munis are also attractive relative to other fixed income investments. When compared to US Treasuries, for example, long-dated munis are the cheapest they’ve been in months. The muni-to-Treasury ratio, which compares the yield on a AAA-rated muni bond to a Treasury with the same maturity, is currently 72% in five years, 77% in 10 years, and 92% in 30 years,3 before adjusting for taxes. This is value for most taxpayers, in our view. Munis offer attractive value, especially toward the longer end of the yield curve, since the muni curve is steeper than the Treasury curve.
Munis have cheapened for several reasons: Uncertainty over tax policy, the high level of muni issuance, and fears of “stagflation,” a combination of slow growth and inflation. These concerns, along with typical tax season pressures and Treasury rate volatility, have caused muni fund outflows since early March, after several consecutive weeks of positive inflows.4
Munis have typically performed well after reaching elevated ratios versus Treasuries. Tax season has historically weighed on munis in March and April as investors adjust portfolios for tax reasons. We expect muni performance to improve during the summer months due to stronger market technicals. Muni issuance is often slower in the summer months, creating less bond supply to be absorbed. Many coupons are paid, and bonds mature in July and August, freeing up funds for reinvestment. Regarding monetary policy, the market appears to be pricing Federal Reserve (Fed) rate cuts as soon as the summer, which should support bond market performance. On the fiscal policy front, we wouldn’t expect tax policy changes that could impact munis to take effect until next year.
We see value in the muni market, given current valuations and market technicals, but we continue to monitor developments related to the Tax Cuts and Jobs Act (TCJA), which is set to expire at the end of this year. We expect the TCJA to be extended in some form, and we don’t expect a dramatically lower tax burden on individuals, which should support muni demand going forward. Legislative proposals related to the tax exemption for munis, the state and local tax (SALT) deduction, private activity bonds, and tax rates have already caused muni market volatility. Continued concerns, especially around the elimination of, or cap on, the tax-exempt status of muni bonds, could cause further market volatility, although this isn’t our base case.
This isn’t the first time the possible elimination or cap on the federal tax exemption for interest income on muni bonds has been discussed. It has been debated for more than 100 years. If the tax exemption is eliminated under a new tax policy, the federal government could collect more revenue, making the extension of the TCJA tax breaks more fiscally feasible. In our view, the cost savings wouldn’t be enough to make the change worthwhile. So, even though the idea may be included in legislative proposals, we don’t think it’s likely to become law. The muni federal tax exemption is valued across the political spectrum, and tax-exempt debt financing is a bipartisan exercise. States and localities at both ends of the political spectrum use it to fund their initiatives. The tax-exempt muni market also offers an efficient and low-cost method of financing infrastructure projects. It’s worth noting that any change — as unlikely as it is — would likely only apply to new bonds, allowing existing bonds to maintain tax-exempt status.
Budget season is around the corner, with 47 out of 50 states starting their fiscal years on July 1. States are grappling with greater than usual uncertainty this cycle amid confusion around federal funding freezes announced by the Trump administration. Many issuers are starting this year from a position of strength. Tax collections, including sales taxes, income taxes, and property taxes, are higher than they were before the pandemic. Governments have also received a tremendous amount of fiscal aid, so reserve balances are generally robust. Their budgets can be scaled back, as they’ve done in previous economic downturns. In addition to reducing spending, issuers can also access the bond markets if necessary to meet financial needs.
Increased uncertainty surrounding fiscal and monetary policy has led to market volatility. The muni market is no exception. We believe muni bonds can help investors navigate the current environment. They’ve historically been a refuge during periods of market turmoil, and we believe they can still be today. Investment grade and high yield muni bonds have historically shown a low correlation with other asset classes, such as US stocks, corporate bonds, and Treasuries. This potential diversification benefit may add value to a portfolio by helping mitigate risk, which is especially important during periods of uncertainty. Additionally, muni bonds currently pay an attractive amount of tax-exempt income on an absolute and relative basis, in our view. (See chart below.)
Within the muni bond universe, we favor essential service revenue bonds, which are issued by entities that provide everyday household needs and are backed by strong revenue streams. We prefer revenue bonds over general obligation bonds since they’re less subject to unfunded pensions and political risk. Strong revenue growth and federal stimulus funds have alleviated pressure on challenged credits in the near term, but some may require pension or budget reform to meaningfully change their long-term credit pictures. Some issuers’ revenue outlook may also depend on the trajectory of the US economy, which has become more uncertain. We favor states and local governments that have used recent revenue growth to build up reserve funds, but their valuations look rich, in our view. There are many non-cyclical muni sectors, such as water, sewer, and public power systems, as well as other essential service revenue bonds, that we prefer. We’re maintaining our investment process and closely monitoring Washington events. We don’t expect to see disruption in the muni market, and we believe that careful sector and credit selection remain key to outperformance.
Source: Bloomberg L.P., data as of March 31, 2025.
Source: Bloomberg L.P., data as of March 31, 2025.
Source: Thomson Reuters, data as of March 31, 2025.
Source: LSEG Lipper. Data from Jan. 16, 2025, to March 31, 2025.
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Important information
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All investing involves risk, including the risk of loss.
Past performance does not guarantee future results.
Investments cannot be made directly in an index.
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.
Correlation is the degree to which two investments have historically moved in relation to each other.
A coupon is the annual interest rate paid on a bond, expressed as a percentage of the face value.
Diversification does not guarantee a profit or eliminate the risk of loss.
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.
A general obligation bond is backed by the credit and taxing authority of the issuer rather than revenue from a project.
High yield bonds, or junk bonds, involve a greater risk of default or price changes due to changes in the issuer’s credit quality. The values of junk bonds fluctuate more than those of high quality bonds and can decline significantly over short time periods.
Inflation is the rate at which the general price level for goods and services is increasing.
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.
Stagflation is an economic condition marked by a combination of slow economic growth and rising prices.
The yield curve plots interest rates, at a set point in time, of bonds having equal credit quality but differing maturity dates to project future interest rate changes and economic activity.
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. The Bloomberg US Municipal Bond Index covers the USD-denominated long-term tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds, and pre-refunded bonds.
The Bloomberg High Yield Bond Index covers the universe of fixed-rate, non-investment grade debt.
The Bloomberg Municipal Bond AAA Index is an unmanaged index of the AAA-rated municipal bond market.
The Bloomberg Municipal Bond AA Index is an unmanaged index of the AA-rated municipal bond market.
The Bloomberg Municipal Bond A Index is an unmanaged index of the A-rated municipal bond market.
The Bloomberg Municipal Bond BBB Index is an unmanaged index of the BBB-rated municipal bond market.
The Bloomberg US Corporate Investment Grade Index is comprised of publicly issued U.S. corporate and specified foreign debentures and secured notes that meet the specified maturity, liquidity, and quality requirements. To qualify, bonds must be SEC-registered. The Bloomberg US Corporate Bond AAA Index is the Aaa component of it. The Bloomberg US Corporate Bond AA Index is the Aa component of it. The Bloomberg US Corporate Bond A Index is the A component of it. The Bloomberg US Corporate Bond BBB Index is the Baa component of it.
The opinions referenced above are those of the author as of April 4, 2025. These comments should not be construed as recommendations but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.
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