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August 2023

Munis Roll into Halftime on a Positive Note

Key Points

  • Technical tailwinds underpin more durable performance potential
  • Attractive tax-exempt income availability anchors asset class preference
  • Remain guarded even with resilient credit conditions

With an eye toward the [historical] seasonally supportive summer months, municipal bonds capped off the first half of the year in a position of strength as robust June returns reversed earlier quarterly weakness. 

Investment grade (IG)1 and high yield municipal (HYM)2 bonds churned out 1% and 1.77% June performance, the strongest monthly gains in at least five years, while year to date (YTD) index returns, per Bloomberg, delivered 2.67% and 4.43% returns, respectively, comfortably outperforming Treasuries. The appetite for municipal bonds remains healthy as cyclically high nominal yields in IG and HYM continue offering long-term investors opportunities to purchase attractive tax-exempt income with the potential to earn additional returns in the coming months. With the economic and policy environment somewhat uncertain, allocating to municipal bonds can improve portfolio defensiveness, capital preservation and diversification, given their relatively low correlation to other asset classes. 

Chart 1: Municipal Tax-Equivalent Yields Offer Relative Value


Source: Bloomberg, as of June 30, 2023 Tax-equivalent yield assumes 37% Federal + 3.8% Medicare Surcharge.
Chart 2: Municipal Bond Returns Solid Year to Date (YTD)*


Source: Bloomberg, as of June 30, 2023.
Past performance or performance based upon assumptions is no guarantee of future results. Indexes are unmanaged and do not reflect a deduction for fees or expenses. Investors cannot invest directly in an index.

The supply deficit YTD, primarily due to lower new issue volume and strong cash flow from maturing bonds and redemptions, contributes to municipal bonds’ recent price support. Bloomberg data shows an approximate 20% YoY decline in gross supply due to higher rates this year as volatility kept issuers on the sidelines. Although many market observers have lowered their full-year estimates, municipal bond supply could improve over the near term if the path of rates becomes clearer. Valuations remain stretched within ten years on the municipal curve as investors have sought refuge in lower-duration securities as the market weighs policy implications and rate trajectory. While longer-dated tenors offer incremental benefits, unanticipated rate volatility would seemingly open up compelling opportunities across the curve to take advantage of more attractive ratios of municipal yields to comparable Treasury securities. Moreover, should municipal bond mutual fund flows achieve more consistent net additions during the second half of 2023, the return outlook could improve, particularly should technical strength persist and rates remain rangebound, allowing coupon “carry” to buffer potential price fluctuations.


Municipal bond credit quality has exhibited a fair amount of resiliency, despite market volatility, inflationary concerns, FOMC policy actions and a slowdown in the economy. With an aged credit cycle and lingering recession risk, albeit diminished, many staple municipal sectors remain in reasonably good shape with sufficient balance sheet resources (i.e., reserves) to counter declines in revenue production. Rating agency upgrades exceed downgrades, defaults remain small and effective issuer management should allow them to navigate potentially slimmer operating margins or discrete shortfalls in their spending plans. Based on recently adopted budgets for state and local governments, the solid fiscal performance over the past two years is receding. Thus, credit selectivity and sector orientation remain key considerations in allocation decisions. 


1 Investment Grade (IG) Municipal Bond Index: The Bloomberg US Municipal Bond Index measures the performance of investment grade, US dollar-denominated, long-term tax-exempt bonds.

2 High Yield (HY) Municipal Bond Index: The Bloomberg Municipal High Yield Bond Index measures the performance of non-investment grade, US dollar-denominated, and non-rated, tax-exempt bonds.

*Indicies used:

Bloomberg Municipal Bond Index: measures the performance of investment grade, US dollar denominated, long term tax exempt bonds.

Bloomberg Municipal Bond High Yield Index: covers the U.S.-dollar denominated, non-investment grade, fixed-rate, municipal bond market and includes securities with ratings by Moody’s, Fitch and S&P of Ba1/BB+/BB+ or below.

Bloomberg Custom Municipal Short 1-5 Index: is the 1 to 5 year maturities of the US Municipal bond index.

Bloomberg Custom Municipal Short-Intermediate 1-10 Index: Index is the 1 to 10 year maturities of the US Municipal bond index.

Bloomberg US Treasury Index: includes all publicly issued, U.S. Treasury securities that are rated investment grade, and have $250 million or more of outstanding face value.

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