Key Themes for Municipal Bond Buyers in 2025

For traders and monetary advisors, these outlooks can function a blueprint for asset allocation choices, sector rotation, and extra funding. For municipal bond traders, which means being attentive to what asset managers like Nuveen should say.

The agency was one of many first to start underwriting municipal bonds earlier than 1900 and has since grown into one of many world’s largest municipal debt managers. As such, its bench power throughout the sector is spectacular. So, when the agency talks about munis, traders ought to pay attention. With that, a brand new paper by the group highlights what traders ought to count on this yr.

After a tumultuous few years, the sleepy municipal bond sector returned to its “boring” nature. Pushed by robust demand, brief provides, and strong taxable-equivalent yields, munis carried out effectively in 2024.

knowledge supplied by Morningstar, we see that the broader municipal bond market and numerous subsectors managed to offer constructive complete returns. Nationwide investment-grade intermediate muni bonds — that are the benchmark of the sector — managed to provide a complete return of 1.89%. Lengthy bonds yielded a return of two.35%, whereas investment-grade brief time period munis supplied a mixture of features and curiosity of two.54%. These traders trying to the high-yield market noticed a robust 4.95% complete return.

General, these are good complete returns for the sector. Nonetheless, they’ve include some volatility. The final quarter of the yr skilled vital worth drops for quite a lot of municipal bond sectors because the Federal Reserve (Fed) began to sluggish the tempo of fee cuts, inflation elevated, and political uncertainty started to have an effect on the markets.
What’s forward for the municipal bond sector? Will traders see comparable outcomes, and the place ought to they focus their consideration to attain the most effective return? Asset supervisor Nuveen could have the reply. Of their current whitepaper, Nuveen outlines 5 key takeaways and themes for the 2025 municipal market.

For starters, present financial coverage considerations will give technique to fiscal insurance policies. And that would present a backdrop for extra municipal bond features. In keeping with Nuveen, the Fed has executed a great job of preventing inflation and has largely gotten it below management. Whereas CPI and different inflationary metrics have begun to tick up in current readings, they’re nonetheless effectively under the Eighties-style numbers seen just some years in the past. With that, the Fed’s fee cuts have began to matter much less.

What is going to drive munis is the rising want for fiscal and tax insurance policies. Nuveen expects a number of key provisions of the 2017 Tax Cuts and Jobs Act (TCJA) to be prolonged below President Trump. Nevertheless, as doubtlessly constructive as these tax cuts are, they’ll result in greater taxes in a while. This gives a backdrop for municipal bond possession.

With rising fiscal coverage considerations, municipal bonds at present have a bonus. Yields and valuations are nonetheless at very compelling ranges. The current pullback in muni bond costs has solely enhanced that reality additional. historic knowledge, the 10-year municipal-to-treasury ratio has been 84%. In keeping with Nuveen, a shift over the past 5 years has allowed ratios to maneuver decrease, with sub-70% ratios the brand new norm. This gives a compelling valuation and unfold between Treasuries and municipal bonds. This chart from Nuveen summarizes their findings and highlights reductions for each 10-year and 30-year maturities.

After diminished provides in 2022 and 2023, final yr noticed a return of many issuers to the muni market. In keeping with Nuveen, muni issuance by October 2024 was 43% greater than final yr at $436 billion. Whereas greater provide could also be counterintuitive at first look, it may very well be good for muni traders.

That’s as a result of yields are already excessive. Increased provides of munis could maintain a lid on costs however will permit traders to get pleasure from a a lot larger yield or money return. That’s key as a result of it units munis again on target to be a low-volatility asset class. Furthermore, it makes them extra enticing in comparison with different bonds akin to investment-grade corporates, which have additionally seen provides rise over the past yr. Presently, munis provide excessive yields and excessive taxable equal yields, offering a greater money return than different taxable bond varieties.

The perfect half is that the growing provides have been met with robust and rising demand, protecting the market in stability. In keeping with Nuveen, the municipal market nonetheless has room to get well. Final yr, robust inflows in muni funds and ETFs of $28.7 billion have been seen. That’s been nice for matching present provides. Nevertheless, it doesn’t come near the $170 billion outflows that 2022 and 2023 noticed. There’s nonetheless extra demand potential.

Nuveen suspects that demand will come again towards the tip of 2025 and into 2026 as returns on money and cash-like asset courses will immediate many traders — particularly high-net-worth traders — to return to the muni market. This may assist absorb further provides and increase general demand.

For traders immediately, this can be a nice time to lock in yields (because of excessive provides/low valuations).

Lastly, Nuveen highlights the credit score high quality of municipal issuers. Regardless of some current hiccups, many states and native governments are nonetheless flush with money. Wet day funds are robust, whereas proactive funds cuts have begun to work their magic. Because of this, Moody’s knowledge present the variety of credit standing upgrades has continued to outpace downgrades by a 3-to-1 margin by the beginning of the yr.

With these robust tailwinds in tow, Nuveen expects that 2025 may very well be one other nice yr for municipal bonds and their traders. The sector’s robust present yields, coupled with some potential demand drivers, will assist generate a robust complete return in comparison with different fixed-income varieties.

On that notice, overweighting munis or including an allocation makes a ton of sense. Nevertheless, like many fixed-income sectors outdoors of treasuries, shopping for particular person munis could also be a tricky nut to crack. To that finish, betting on numerous ETFs and funds is sensible. Lively administration might play a big function in boosting the efficiency of a muni bond portfolio.

Lively Municipal Bond ETFs

These ETFs have been chosen primarily based on their potential to offer low-cost and lively publicity to the municipal bond market. They’re sorted by their 1-year complete return, which ranges from 1.9% to 9.1%. They’ve expense ratios between 0.07% and 0.65% and belongings below administration of $240M to $3B. They’re at present yielding between 2.9% and 5%.

Passive Municipal Bond ETFs

These funds have been chosen primarily based on their publicity to municipal bonds at a low price. They’re sorted by their one-year complete return, which ranges from 1.8% to six.5%. They’ve expense ratios between 0.05% and 0.35% and belongings below administration between $2.8B and $42B. They at present provide yields between 2.4% and 4.4%.

All in all, Nuveen’s thought course of highlights why municipal bonds needs to be part of your fastened revenue allocation this yr. Demand and excessive yields will finally profit traders and result in constructive complete returns.

Municipal bonds had a great 2024, offering robust complete returns. In keeping with Nuveen, the brand new yr additionally guarantees to be robust. Low valuations, excessive yields, and adjustments to tax insurance policies all bode effectively for the sector and traders going ahead.