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January 2022

Investment Grade Municipal Bonds Demonstrate Resiliency

Key Points

  • Expect modestly positive total returns
  • Market volatility should create investor opportunities
  • Issuer credit quality is improving

Investment grade municipal (IGM) bonds closed the book on 2021 with more optimism as market gains in the final months boosted full-year total returns to about 1.5% (Bloomberg Barclays indices), delivering good relative outperformance versus most other fixed income cohorts.

Despite fluctuations in the rates market, IGM bonds benefitted from solid investor demand with robust fund flows. The improving economy contributed to shrinking credit spreads while talk of higher personal and corporate income tax rates bolstered the appeal of tax-exempt income. The technical factors influencing IGM bonds should carry over into 2022. However, some downside risks remain, with Fed lift-off anticipated in 2H2022 (or sooner). A more rapid and sustained rise in rates than expected could weigh on the municipal market. That said, municipal bonds tend to perform well during a rising rate environment. Although IGM bond performance may be more muted in 2022, investors should earn modestly positive total returns.


The municipal market will continue to focus on valuations. Relative value indicators such as the municipal/Treasury yield ratio ended 2021 near their historic lows, while credit spreads tightened significantly. Should IGM bonds track a more aggressive adjustment in Treasuries and demand weaken from slowing and/or periodic outflows, valuations should “cheapen” with ratios moving higher. Any dislocation in the municipal bond market has potential performance implications, but we see these events as opportunities for investors to capitalize on more attractive entry points.

Municipal credit conditions improved during 2021, with many state and local governments (SLGs) reporting strong revenue outperformance versus forecasts. Based on projections, many SLG balance sheets are healthy and poised to grow in FY 2022. Spending on infrastructure will increase over the next few years as money appropriated from the Infrastructure Investment and Jobs Act flows through various municipal sectors. Investments in physical projects should stimulate growth and be a net positive for municipal credit quality. We continue to monitor governance and policy decisions to ensure SLGs maintain budgetary balance, especially as we face headwinds from COVID-19 variants and likely changes in the political landscape in 2022.

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