Muni Market Crosscurrents

For traders with huge positions in muni bond holdings, lowering these stormy seas is paramount.

Fortunately, there are methods to navigate these crosswinds and probably end the 12 months with some positive aspects, all whereas accumulating earnings. With these methods in thoughts, munis can return to being a boring, earnings generator for a portfolio.

Municipal bond traders are a comparatively conservative lot. Bonds issued by state and native governments have a tendency to not bounce round an excessive amount of and their traders sit again whereas accumulating their coupon funds. With that in thoughts, the present muni atmosphere is wanting a bit tough.

Whole returns for the fastened earnings asset class clocked in at optimistic 1.9% for all of 2024. Given the 4% yields on many muni bond indexes, that suggests the bonds’ costs managed to say no and yield/coupons managed to ship the optimistic efficiency.

The explanations for the worth declines are a combination of financial and geopolitical points.

For starters, municipal bonds might lose their tax-exempt standing. Many lawmakers wish to broaden parts of the Tax Cuts & Jobs Act because the invoice sunsets this 12 months. Nonetheless, burgeoning deficits from the invoice and potential tax cuts imply tax will increase elsewhere would possibly must be proposed. That has munis’ tax-exempt standing now in query and probably within the crosshairs. Given the uncertainty and rapidly altering coverage factors the Trump Administration is thought for, many muni bond consumers and holders have begun promoting.

On the similar time, tariffs and continued rising inflationary pressures have began to impression long-term bonds as soon as once more. The Federal Reserve would possibly want to lift charges to fight the inflationary pressures. This has put munis below a further lens as they typically have longer maturities and durations.

Issuances of muni bonds have additionally elevated in current quarters as many states have taken benefit of decrease present charges to fund their steadiness sheets and problem debt extra cheaply.

And but, these headwinds have been met with some very sturdy tailwinds propelling the muni sector.

That features a number of the highest beginning yields in years. In response to funding supervisor and muni bond specialist, Nuveen, municipal yields began 2025 on the highest degree in almost 15 years. Proper now, muni bonds are yielding 122 foundation factors above their 20-year trailing common.

Furthermore, the after-tax yield is considerably increased versus Treasury bonds, even when we have been to account for taxes in that yield and the potential for the sector to lose its tax-exempt standing. This chart from Goldman Sachs highlights the unfold.

 
Supply: Goldman Sachs

Then there may be the state’s well being as properly. Steadiness sheets and rainy-day funds are nonetheless sturdy, whereas prudent finances administration has continued to repay. This has enhanced the credit score high quality of muni bonds.

So, on the one hand, muni traders have confronted probably nasty woes throughout tax standing, geopolitical points, and rising inflationary pressures. However, they’re at present providing a number of the fattest yields and strongest credit score profiles in almost twenty years. Making an attempt to steadiness the positives of the sector versus a number of the negatives is a high quality line to stroll. However there are methods to try this.

In response to AllianceBernstein, there are 4 methods traders can observe to navigate the crosswinds and add ballast to their municipal bond boat.

The 1st step might be to selectively lengthen your length. By going out on the yield curve, traders can make the most of falling yields after they come or assist clip extra earnings at the moment. If issues proper themselves and the Fed can as soon as once more begin slicing charges as initially predicted, bond costs on the lengthy finish of the curve will rise. If they’re compelled to maintain charges the identical for some time, traders can clip extra earnings from these bonds.

However by going lengthy, traders are uncovered to length danger. That is why AllianceBernstein additionally recommends a barbell technique, which mixes short- and long-term maturity bonds. This enables traders to have their cake and eat it too. The short-term bonds defend towards rising charges, whereas the long-term bonds defend towards falling. In response to AllianceBernstein, a barbell technique would have market-beating returns final 12 months.

Third, traders ought to look past investment-grade munis for returns. The high-yield market has lengthy been a supply of outsized yields at solely barely higher-risk profiles. Non-investment grade, BBB-, and A-rated bonds at present have yields of almost 6%. Nonetheless, many so-called high-yield munis nonetheless provide sturdy credit score profiles and extra riders for reimbursement.

Lastly, AllianceBernstein recommends staying versatile. The connection between high-grade municipals and U.S. Treasuries is commonly altering. This relationship has lengthy signaled nice gadgets to purchase munis for sturdy whole returns. Being extra energetic along with your muni bond portfolio may repay and supply a technique to decrease volatility within the new 12 months.

Given the sturdy yield attraction and potential for positive aspects, munis are nonetheless a prime draw. However traders have to work towards navigating the headwinds. Following AllianceBernstein’s recommendation and utilizing length as a software, in addition to being selective in credit score, barbelling, and timing purchases, makes quite a lot of sense. Fortunately, there are many methods to attain a portfolio below this framework. ETFs could make quick work of this.

For instance, the VanEck Lengthy Muni ETF and SPDR Nuveen Bloomberg Brief-Time period Municipal Bond ETF might be paired for a barbell technique. An energetic ETF might be used to seek out alternatives, whereas traders may chubby a high-yield muni ETF to achieve credit score publicity. The thought is to not be static and easily purchase a broad muni index and experience out the waves.

Lively Municipal Bond ETFs

These ETFs have been chosen primarily based on their potential to offer low-cost and energetic publicity to the municipal bond market. They’re sorted by their YTD whole return, which ranges from 0.4% to 1.6%. They’ve expense ratios between 0.12% and 0.65% and property below administration of $128M to $2.6B. They’re at present yielding between 2.5% and 4.4%.

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 YTD whole return, which ranges from 0.2% to 1.1%. They’ve expense ratios between 0.03% and 0.35% and property below administration between $2.8B and $42B. They at present provide yields between 2.7% and 4.4%.

All in all, the municipal bond sector has loads of potential, but in addition loads of headwinds. For traders, navigating these points can result in loads of sturdy returns because the market performs out. By being selective, barbelling, and credit score alternatives, traders can take advantage of the present muni sea and win.

Municipal bonds have been fairly risky over the previous few months. And most of the developments creating that volatility haven’t stopped. However traders shouldn’t surrender hope. There are methods to play the muni market and revenue.