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January 2022

High Yield Municipals Best in Class

Key Points

  • Coupon income to drive positive, albeit moderate, returns in 2022
  • Credit trends should continue to benefit from an improving economy
  • Market dislocation should create attractive entry points for investors

High yield municipal (HYM) bonds got back on track during 4Q2021 to close out an otherwise volatile year for fixed income assets. According to Bloomberg and Barclays indices, HYM added more than 100 bps of total return during the quarter, propelling full-year gains above 7.75% and delivering relative solid outperformance.*

The technical underpinnings that persisted for most of the year, such as positive fund flows, along with a fundamental improvement in credit quality from a recovering economy, contributed to higher prices of HYM bonds that position the asset class well to begin 2022. Total returns should moderate in line with “clipping your coupon.” That said, HYM bonds are poised to outperform investment grade municipals and Treasuries, providing above-market income and an inflation cushion for investors.


Our forecast for more limited return upside potential reflects narrow credit spreads that compressed significantly throughout 2021 as investors felt more comfortable assuming additional issuer risk in an otherwise low-yield environment. However, given our favorable outlook for the economy and GDP growth in 2022, HYM bonds could remain at current valuations for some time, particularly in the short run, as demand and supply imbalances point to continued price support. A risk to the downside could develop toward the back half of 2022 (or sooner) as policy accommodation diminishes. Should municipal market demand weaken (i.e., slower fund flows or intermittent outflows) and rates react more aggressively to a shift in monetary policy, HYM bond performance could undershoot estimates. Still, we view these events as opportunities for investors to take advantage of more attractive valuations and to book incremental yield.

Issuer credit quality should benefit from an improving economy in 2022. HYM could experience an uptick in troubled borrowers should market access wane, but this would be unlikely to create a systemic challenge to the generally constructive credit backdrop. While the year-end 2021 market par value in default was less than 0.4% (ex- Puerto Rico), City National Rochdale continues to exercise diligent security selection and sector bias within the HYM space to avoid unnecessary risk exposure for client portfolios.


* Indices are unmanaged and one cannot invest directly in an index. Index returns do not include fees for trading costs (i.e., commissions) or any fees charged by your financial advisor, custodian, City National Rochdale or other third-party managers, and if they were included would reduce the returns.

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