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Municipal Bonds

Taxable municipal bonds: headwinds of 2022 could be tailwinds of 2023

Daniel J. Close
Head of Municipals
Andrew J. Luberto
Client Portfolio Manager
High rise buildings and sky

Key takeaways

Taxable municipal bond market performance remained volatile during the fourth quarter as credit spreads peaked to their year-to-date highs during October. Nevertheless, low new issue supply and a more rangebound U.S. Treasury yield environment led to improved performance. Municipals ended the year with positive fourth quarter returns. Looking ahead, inflation should continue declining and the U.S. Federal Reserve should acknowledge this trend. In this case, the macro tailwind should help bolster strong demand for taxable municipals and contribute to a rally in 2023.


A positive fourth quarter creates momentum heading into 2023

Macroeconomic factors came more into balance late in 2022. For example, while 12-month trailing inflation remains very high, the last five months’ trajectory is in line with the U.S. Federal Reserve’s (Fed) target. The Fed remains determined to fight inflation, but we have seen a subtle shift in its hawkish tone and a decelerating pace of rate hikes.

Supply chain problems have eased significantly. And while the labor market remains strong, people going back to work is ultimately positive for the economy. Average hourly earnings growth has slowed with rising participation in the labor market.

However, U.S. Treasury rates rose only slightly in the fourth quarter, a marked contrast to the first three quarters.

This more balanced interest rate picture fueled positive performance during the fourth quarter. The positive returns can be further boosted as credit spreads begin to narrow amid improving sentiment and strengthening investor demand.

This resilience in the face of a volatile macro environment and Fed tightening offers several reasons for optimism in 2023. Taxable municipal returns have historically bounced back strongly the year after a year of negative returns. This trend is supported by higher yields that attract new capital to the market. While economic and Fed policy uncertainty will likely lead to more periods of U.S. Treasury rate volatility in 2023, taxable municipals are cushioned by much higher yields.

Traditional municipal bond factors took a back seat to Fed policy in 2022, but these elements look favorable overall heading into 2023. Upgrades outpacing downgrades in the face of high inflation underscore the monopolistic presence of municipal issuers and the essential services they provide. And the low supply of taxable municipal bonds together with strong credit fundamentals position the asset class well for a possible recession. We believe a less active Fed should pave the way for these municipal factors to create a market recovery this year.

Municipal market themes for 2023

Economic environment

Municipal market environment

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Gross Domestic Product: U.S. Department of Commerce. Treasury Yields and municipal credit spreads: Bloomberg (subscription required). Issuance: Seibert Research. Defaults: Municipals Weekly, Bank of America/Merrill Lynch Research. State Revenues: The Nelson A. Rockefeller Institute of Government, State Revenue Report. State Budget Reserves: Pew Charitable Trust. Global Growth: International Monetary Fund (IMF) and the Organisation for Economic Co-operation and Development (OECD). Standard & Poor’s and Investortools: Flow of Funds, The Federal Reserve Board: Payroll Data: Bureau of Labor Statistics. Bond Ratings: Standard & Poor’s, Moody’s, Fitch. New Money Project Financing: The Bond Buyer. State revenues: U.S. Census Bureau.

The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Past performance does not predict or guarantee future results. Investing involves risk; principal loss is possible.

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. For term definitions and index descriptions, please access the glossary on Please note, it is not possible to invest directly in an index.

Important information on risk

Investing involves risk; principal loss is possible. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Investing in municipal bonds involves risks such as interest rate risk, credit risk and market risk. The value of the portfolio will fluctuate based on the value of the underlying securities. There are special risks associated with investments in high yield bonds, hedging activities and the potential use of leverage. Portfolios that include lower rated municipal bonds, commonly referred to as “high yield” or “junk” bonds, which are considered to be speculative, the credit and investment risk is heightened for the portfolio. Bond insurance guarantees only the payment of principal and interest on the bond when due, and not the value of the bonds themselves, which will fluctuate with the bond market and the financial success of the issuer and the insurer. No representation is made as to an insurer’s ability to meet their commitments. This information should not replace an investor’s consultation with a financial professional regarding their tax situation. Nuveen is not a tax advisor. Investors should contact a tax professional regarding the appropriateness of tax-exempt investments in their portfolio. If sold prior to maturity, municipal securities are subject to gain/losses based on the level of interest rates, market conditions and the credit quality of the issuer. Income may be subject to the alternative minimum tax (AMT) and/or state and local taxes, based on the state of residence. Income from municipal bonds held by a portfolio could be declared taxable because of unfavorable changes in tax laws, adverse interpretations by the Internal Revenue Service or state tax authorities, or noncompliant conduct of a bond issuer. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager.

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