The case for munis The case for munis\images\insights\article\building-city-hall-small.jpg November 30 2022 November 30 2022

The case for munis

Municipal securities have much to offer if the economy slows.

Published November 30 2022
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The search for good fixed-income opportunities in this rough year have sent investors across sectors and the globe. But the answer might be sitting in front of them, as municipal bonds seem poised to offer good value.

Whether the Federal Reserve raises rates by 50 or 75 basis points at its mid-December policy-setting meeting, its quest to curb inflation likely will push the U.S. into a mild recession. In past downturns, the municipal market has significantly outperformed domestic investment-grade corporate bonds from peak to trough. Backed by tax revenue, municipalities tend to be less sensitive to the factors that corporations face in economic slowdowns. In past periods, municipal securities have had significantly fewer defaults relative to corporates at every level of the credit-quality spectrum. Not to be forgotten is that many municipalities remain flush with cash from the Covid-related federal stimulus programs. It’s hard to over-emphasize the positive impact this has had on credit quality. Upgrades continue to outpace downgrades, including states that have long had low ratings, such as Illinois and New Jersey.

Often overlooked in a period of negative returns such as 2022 is the primary reason to hold all bonds: income. With yields higher than they have been in more than a decade—the 30-year BVAL AAA municipal yield is 3.57% as of today (compared to 1.54% at the beginning of the year)—muni bonds are meeting this goal with attractive income. That becomes more appealing when considering the taxable-equivalent yield—the reason most people turn to munis in the first place. The taxable-equivalent yield-to-worst(YTW) of the Bloomberg Municipal High Grade Bond Index for an investor in the highest tax-bracket is 6% versus the 4.56% YTW of the benchmark U.S. Aggregate Index and 5.31% of the Bloomberg U.S. Corporate Investment-grade Index. That’s compelling, to say the least.

In 2022 so far, bonds have shed their long-held reputation of offering protection, with nearly every fixed-income asset class having the worst year in decades, or longer. (Deutsche Bank research claims it’s the worst total return for U.S. Treasuries since the signing of the U.S. Constitution!) But the defensive nature of municipals could offer a haven in 2023, and perhaps much more.

Tags Markets/Economy . Taxes . Fixed Income . Interest Rates . Inflation .

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Bloomberg US Aggregate Bond Index: An unmanaged index composed of securities from the Bloomberg Government/Corporate Bond Index, Mortgage-Backed Securities Index and the Asset-Backed Securities Index. Total return comprises price appreciation/depreciation and income as a percentage of the original investment. Indices are rebalanced monthly by market capitalization. Indexes are unmanaged and investments cannot be made in an index.

Bloomberg Municipal Bond Index: A market-value-weighted index for the long-term tax-exempt bond market. To be included in the index, bonds must have a minimum credit rating of Baa. They must have an outstanding par value of at least $7 million and be issues as part of a transaction of at least $75 million. The bonds must be fixed rate, have a dated-date after December 31, 1990, and must be at least one year from their maturity date. Indexes are unmanaged and investments cannot be made in an index.

Bloomberg US Corporate Bond Index measures the investment-grade, fixed-rate, taxable corporate bond market. 

The Bloomberg Valuation Service (BVAL) Muni Benchmark is populated with high-quality U.S. municipal bonds with an average rating of AAA from Moody's and S&P. Its yield curve is built using non-parametric fit of market data obtained from the Municipal Securities Rulemaking Board, new issues calendars and other proprietary contributed prices. Represents 5% couponing. Index names/tickers ending in T or Y are based off a rolling tenor.

Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.

Municipal bond income may be subject to the federal alternative minimum tax (AMT) and state and local taxes.

Past performance is no guarantee of future results.

Federated Investment Management Company