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Fixed income

Taxable municipal bonds: Starting strong

Daniel J. Close
Head of Municipals
Kristen M. DeJong
Portfolio Manager
Andrew J. Luberto
Client Portfolio Manager
Bridge and water

In the fourth quarter, the taxable municipal bond market posted its strongest quarterly return since 2011. Taxable municipals rallied in sympathy with U.S. Treasuries on expectations that the U.S. Federal Reserve (Fed) will begin easing rates in 2024. While rates have rallied from the highs, yields are at their highest point to start a year since 2011. We believe portfolios should be rewarded by assuming a modestly longer duration profile while selectively adding credit through essential service providers.

Key takeaways


Many reasons for confidence

We believe the taxable municipal market is poised for improvement in 2024, depending on how the economy responds to the end of Fed rate hikes. The Fed and others believe a soft landing is still possible, but we remain unconvinced. Regardless, we believe municipal credit may help stabilize investment portfolios.

While the Fed’s torrid pace of rate hikes has impacted taxable municipal bond yields, credit fundamentals remain strong. State and local governments remain flush with cash after several rounds of stimulus during the pandemic, and revenues remain well above pre-pandemic averages.

Taxable municipal bonds should be well placed to capitalize on these solid fundamentals, with yields starting 2024 at their highest level since 2011. In this environment, investors may enjoy attractive total returns from income alone, a dynamic absent for nearly a decade.

2023 was the second consecutive year of increased market volatility for municipals, keeping some investors out of the market as they wait for the end of the Fed’s hiking cycle. We believe attractive absolute yield levels should encourage demand once investors remaining on the sidelines feel confident the Fed’s rate hikes are done.

Total new issue supply ended 2023 down 2% compared to 2022, the second consecutive year of lower year-over-year supply. Taxable municipal supply was even more suppressed, ending the year down -31% compared to 2022 levels. If investor sentiment shifts positively, as we expect, strengthening demand could absorb secondary market supply and act as a further catalyst for spread tightening given the scarcity of new issue paper over the last two years.

With a focus on fundamental strength, we believe municipal bonds have attractive potential in well-diversified, long-term portfolios.

Economic environment
Municipal market environment

Full report

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