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February 2023

Munis Positioned to Gain on Momentum

Key Points

  • Attractive municipal yields poised to garner investor attention
  • Technical backdrop likely more supportive near term
  • Credit fundamentals remain durable but investors should focus on quality

Municipal bond investors wrapped up a challenging 2022 as rising prices generated relatively solid performance during Q4, with Bloomberg indices reporting roughly 4.0% and 3.5% total returns for investment grade (IG) and high yield (HYM) municipal bonds, respectively.

Despite persistently aggressive Fed actions to quell the highest inflation in decades, and associated interest rate volatility, IG and HYM bond investor optimism gained momentum in the year’s final months. The repricing of yields across the curve of about 150–250 basis points has fostered a more attractive entry point to lock in and earn a healthy future income stream. Municipal bonds should advance further as compelling yields lure investors and technical factors support stronger valuations.


A hard-to-ignore theme of 2022 focused on municipal bond mutual fund redemptions that reached record levels, based on US Lipper data. While outflows linger, we expect the end of tax loss harvesting to help moderate negative flows. Normalization will likely occur during 1H2023 as seasonal factors, such as insufficient supply, catalyze investor demand amid higher yields. Gross supply declined about 20% year-over-year in 2022 and will likely remain constrained in 2023 as higher rates suppress refunding opportunities. In the near term, reinvestment needs are expected to outstrip available supply, leading prices higher and keeping municipal-to-Treasury ratios more expensive on short and intermediate areas of the curve. However, the long-term benchmark offers more attractive valuations. A change in market sentiment where spreads widen or valuations become more desirable is an opportunity to put cash to work.

Municipal bonds have exhibited resiliency throughout economic cycles. Healthy reserves entering 2023 should safeguard against the diminution of credit quality for most state and local governments. Distress indicators for HYM bonds remain fairly low but warrant careful due diligence in sourcing appropriate risk exposures. IG municipal bond rating trends have been positive since 1Q2020 and should stay favorable, albeit more balanced, in the year ahead. We continue to exercise caution in some revenue bond sectors that may have recovered more unevenly since the pandemic or remain under pressure from macroeconomic influences. Acknowledging issuer diversification within the municipal market and differences in fiscal performance, we continue to advocate for higher-quality bonds with an overall focus on security selection.


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