Muni bonds still offering income opportunities

Bottom line up top:

• Tag along with tech stock gains and tempered tariffs... With under two weeks until the Trump Administration’s 01 August tariff deal deadline, both the S&P 500 Index and the tech-heavy Nasdaq Composite continue to flirt with and reach new closing and intraday highs. This has been propelled in part by generally cooler-than-expected inflation data, including last week’s benign CPI and PPI prints, which have yet to show any significantly negative impact from higher tariffs. Moreover, investors seem to be betting that changes to U.S. global trade policy, once finalized and implemented, won’t be as extreme as headlines and social media posts suggest.
  
  …or consider reducing risk? The recent resurgence of technology-driven equity appreciation has brought with it frothy valuations both for tech-oriented sectors and the overall market. The S&P 500’s information technology sector is valued at roughly 30x forward earnings, while the overall index is at 22x — representing hefty premiums versus their respective historical averages. And while last week’s unofficial kickoff of second quarter earnings season showcased decent results, analysts have lowered their full-year earnings estimates for nine of the 11 sectors in the S&P 500.
  
  With this in mind, how might investors who are struggling to reconcile continued potential upside for U.S. equities with a heightened degree of uncertainty (Figure 1) want to position their portfolios? One idea worth considering is incremental exposure to municipal bonds. The asset class continues to offer attractive yield and return potential, and recently breathed a sigh of relief as it retained its tax-exempt status despite other big changes to the federal tax code.

Portfolio considerations

The recently enacted “One Big Beautiful Bill” (OBBB) left the tax-exempt status of municipal bonds intact, a key victory for the asset class. Preserving the exemption gives municipalities across the country a cost-effective way to finance essential infrastructure projects.

Another provision temporarily raises the cap on state and local tax (SALT) deductions, from $10,000 under the 2017 Tax Cuts and Job Act to $40,000 for the 2025-2029 tax years. The higher cap, which will reduce the tax burden of some residents in high-tax states, phases out for those earning more than $500,000. Jurisdictions with high local taxes could see taxpayers migrate to lower-tax states if the deduction cap reverts.

We further analyzed the OBBB through the lens of three main policies to determine the potential impacts on municipal issuers. The results suggest that some of the “beauty” of the OBBB may be in the eye of the beholder:

• Tariffs. Expanded aluminum and steel tariffs increase capital project and borrowing costs for municipalities. Electric, water and sewer utilities that need capital investment may pass higher construction costs on to customers via rate increases. However, more relaxed environmental regulations and enforcement might alleviate near-term cost pressures. Separately, port volumes may be pressured and are bracing for declines in shipping of raw materials and other inputs.
• Energy policy. The rollback of renewable energy and manufacturing tax credits could hinder energy production capacity and raise electric utility rates. Specifically, tax credits for solar and wind energy projects will no longer be available after 2027, making renewable power generation more expensive. Additionally, electric vehicle (EV) tax incentives will be phased out after September 2025, and tax credits for charging stations will expire after June 2026. This may dampen the momentum of planned city and state transitions to EV.
• Immigration. Federal funding is at risk for cities and counties identified as sanctuary jurisdictions. School districts with undocumented students could face enrollment declines. Large urban districts will likely be more vulnerable to losing students and federal K-12 aid cuts, and those that lose aid may have to issue additional debt to replace funding.

Despite some challenging aspects of the OBBB, municipal bonds continue to offer compelling yield and income benefits. Current yields of 4.03% for investment grade munis (ICE BofA U.S. Municipal Securities Index) rank in the 95th percentile over the past decade, while high yield munis are yielding 5.72% (S&P Municipal High Yield Index). Income has historically been the primary driver of muni total returns (Figure 2). Though market volatility will likely persist, municipal bonds remain well-positioned to deliver attractive income levels.

Nuveen’s Global Investment Committee (GIC) brings together the most senior investors from across our platform of core and specialist capabilities, including all public and private markets.

Regular meetings of the GIC lead to published outlooks that offer:

• macro and asset class views that gain consensus among our investors
• insights from thematic “deep dive” discussions by the GIC and guest experts (markets, risk, geopolitics, demographics, etc.)
• guidance on how to turn our insights into action via regular commentary and communications