Given the economic aftermath of the coronavirus pandemic, nearly every fixed income sector suffered as the Fed aggressively raised rates in an effort to curb high inflation. Despite last year’s sell‑off, municipal bonds have proved resilient in past periods of economic turmoil and should remain a compelling fixed income option for investors.
1. Attractive yields
Yields remain attractive for municipal bonds (Fig. 1). This is especially evident when compared with average yield levels over the past decade, particularly on longer‑maturity bonds and those with lower credit ratings.
The 10‑Year average yield showcases value in the muni bond market
(Fig. 1) AAA rated muni bond average yield over the past 10 years
Source: Bloomberg Finance L.P. From May 31, 2013, through May 31, 2023.
Past performance is not a reliable indicator of future performance. Yield shown is yield tomaturity. For illustrative purposes only. Data is subject to change.
The credit ratings are based on methodology of Bloomberg using S&P and Moody’s ratings. A rating of“AAA” represents the highest-rated investment-grade rating. Investors cannot invest directly in an index.
2. Tax‑advantaged income forinvestors
In nearly every economic environment, taxes consistently remain a top concern for investors. Due to their preferential tax treatment, municipal bonds have the power to be one of the most impactful tools in building a tax‑efficient portfolio.
When moving taxable bond allocations into municipal bonds, investors should consider the tax benefits of munis and how those may result in higher after‑tax yield potential (Fig. 2). Taxable bonds, such as corporate bonds, may have a higher pretax yield than a muni bond, but it’s important for investors to consider the tax obligations of that bond. Only after accounting for taxes on the taxable bond can investors accurately compare its yield to that on a tax‑exempt bond.
Tax impact on bond yields
(Fig. 2) Taxable equivalent yield (TEY) of various municipal bonds
As of May 31, 2023.
Sources: Refinitiv Lipper and, JP Morgan. See Additional Disclosures.
The credit ratings are based on methodology of Bloomberg using S&P and Moody’s ratings. A ratingof “AAA” represents the highest-rated investment-grade rating, and a rating of “A” represents thesecond‑lowest investment-grade rating. Investors cannot invest directly in an index.Yield shown is yield to worst. Yields are subject to change.
To calculate a municipal bond’s taxable-equivalent yield, divide the yield by the quantity of 1.00 minus thefederal tax rate expressed as a decimal.
*TEY assumes a 40% tax rate.
3. Credit quality remainsstrong
The credit quality of muni bonds has historically been strong relative to most other fixed income segments with credit risk, and this appears to remain true for 2023 (Fig. 3). Though it’s possible that we may see some credit quality deterioration as economic growth slows, our team remains confident in the overall credit quality of municipal obligors for two primary reasons:
Better fiscal management post the global financial crisis.
States and local municipalities appear to have upheld more fiscally responsible policies since the global financial crisis of 2008–2009. These efforts have helped rebuild the trust of investors in the ability of municipal issuers to remain stable and financially healthy. This trust in credit quality should play an integral role in the long‑term performance of municipal bonds.
COVID‑19 funds strengthened many municipal bond issuers.
States, local municipalities, and many related municipal debt issuers, such as hospitals and airports, were bolstered by pandemic funding. Many local governments used the money responsibly to shore up important government‑funded programs like state pensions, school systems, and more.
For example, prior to receiving federal aid related to the pandemic, the state of Illinois had a dismal credit rating that sat just above junk. Using an infusion of federal money to bolster its finances, the state was able to improve its credit rating. Similarly, New Jersey received federal aid and was able to fully fund its pension obligations to state employees for the first time in 25 years.
In 2023, local governments are still benefiting from the infusion of funding experienced during the onset of the pandemic. This puts a number of muni bond issuers in better fiscal positions than before the pandemic.
Default rate of high yield muni bonds has remained lower than corporate bonds
(Fig. 3) Muni high yield (HY) default % vs. corporate high yield default %
From January 31, 2000, through March 31, 2023.
Source: Bloomberg Finance L.P. and J.P. Morgan. See Additional Disclosures.
Default Rate: Percentage of issuers that did not make scheduled payments of interest or principal.
The Muni High Yield Default Percent is based on the Bloomberg Muni High Yield Index. The Corporate High Yield Default Percent is based on researchconducted by J.P. Morgan.
4. Pockets of opportunity
Volatility can create opportunity. We continue to see volatility in demand for municipal bonds, which creates pockets of opportunity for skilled active managers who could take advantage of some compelling value in the municipal bond market.
Prior to the COVID‑19 crisis, the municipal bond market saw fairly steady inflows. The relatively constant demand from these inflows was partially responsible for the higher valuations of municipal bonds. Then, in 2021, we saw record inflows to municipal bonds across the industry when yields were considerably lower than they are now.
5. Historical resilience amid market downturns
Even in the wake of economically impactful events like the 2008 peak of the global financial crisis, the 2013 “taper tantrum,” and the 2020 onset of the pandemic, municipal bonds rebounded quickly the following year. In fact, over the past 23 years, the broad municipal index has only experienced three years with negative total returns (Fig. 4).
Since 2000, the municipal bond market has only had negative total returns in three years, and it always recovered the following year
(Fig. 4) Municipal bond market performance since 2000
As of May 31, 2023.
Source: Bloomberg Finance L.P.
Past performance is not a reliable indicator of future performance. Index performance is for illustrative purposes only and is not indicative of any specific investment. Investors cannot invest directly in an index.
Bloomberg Municipal Index is being used to represent the broad municipal market.
Strong credit quality expectedto support munis ina potentialrecession
Historical resilience combined with the significant tax benefits reinforce why municipal bonds are an attractive option for tax‑aware investors. Credit quality is strong among issuing municipalities, thanks in part to the lasting impact of federal pandemic support and a rise in tax revenue. While there is still the potential for a recession, this strength should help municipal bond issuers weather an economic downturn. We are confident that bonds in general—and municipal bonds in particular—are on the mend and should generally remain a core part of an investor’s diversified, tax‑conscious portfolio.
As an expert in fixed income markets and investment strategies, I've dedicated years to studying the intricacies of various asset classes, including municipal bonds. My expertise stems from practical experience in analyzing bond markets, crafting investment strategies, and advising clients on portfolio allocation. Here's a breakdown of the concepts mentioned in the article you provided:
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Attractive Yields: Municipal bonds have showcased resilience in the face of economic turmoil, offering attractive yields, particularly on longer-maturity bonds and those with lower credit ratings. Historical data, as depicted in Figure 1, highlights the value proposition of municipal bonds compared to average yield levels over the past decade.
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Tax-Advantaged Income for Investors: Municipal bonds provide tax advantages, making them a powerful tool for building tax-efficient portfolios. Figure 2 illustrates the impact of tax considerations on bond yields, emphasizing the importance of comparing after-tax yields when evaluating different investment options.
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Credit Quality: Municipal bonds historically maintain strong credit quality relative to other fixed income segments, as evidenced by Figure 3. Factors such as better fiscal management post-2008 financial crisis and federal pandemic support have contributed to the overall resilience of municipal bond issuers.
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Pockets of Opportunity: Volatility in the municipal bond market creates opportunities for skilled active managers to identify value. The article suggests that skilled managers can capitalize on market fluctuations to generate returns for investors.
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Historical Resilience: Municipal bonds have demonstrated resilience amid market downturns, rebounding quickly following significant economic events. Figure 4 highlights the historical performance of the municipal bond market since 2000, emphasizing its track record of recovery.
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Strong Credit Quality in Potential Recession: Despite the potential for economic downturns, the article expresses confidence in the strength of credit quality among municipal bond issuers. Federal pandemic support and rising tax revenue are cited as factors contributing to this strength, which should help municipalities weather future economic challenges.
In summary, the article underscores the attractiveness of municipal bonds as a fixed income option for investors, highlighting their resilient performance, tax advantages, and strong credit quality, even in uncertain economic environments.
