Credit conditions for most municipal issuers are expected to remain positive in 2022, and defaults are expected to stay low. Increases in business and income taxes have boosted revenues. Issuers with higher revenues have more financial freedom. Furthermore, because property taxes are typically the main source of revenue for local governments, the improved property market should benefit them.
Is it wise to invest in municipal bonds in 2022?
The key drivers of the municipal market are all positive, therefore 2022 is expected to see ongoing robust demand for municipal bonds. Taxes are first and foremost. Investors are still concerned about increasing taxes and will do everything possible to avoid them, keeping demand high.
Will municipal bond funds make a comeback?
- As states and local governments faced with revenue disruptions, the Fed assisted in reviving the muni-debt market.
- As investors return to muni-bond funds and capital markets reopen, inflows and issuances have increased.
- Lower-rated assets, in our opinion, present the highest risk and reward for investors.
Fed’s muni-debt program provides lifeline
Congress has also pushed trillions of dollars into the economy as part of the stimulus package. Individuals, businesses, and hospitals received relief from the $2.2-trillion CARES Act, which also set aside $150 billion in federal fiscal support for state and local governments. The medium-term economic outlook has stabilized, municipal bond fund flows have turned positive, and spreads (the risk premiums investors demand to hold these securities over U.S. Treasuries) have reduced as funds from these programs make their way through the economy. These trends have aided the popularity of municipal bonds in recent months.
Finding opportunities in uncertain times
Investors are rushing back into municipal debt, hungry for yield and seeking more protection than the stock market can deliver, despite the fact that coronavirus losses are weighing hard on state and city coffers. Municipal bond mutual funds have seen steady inflows. Defaults account for a minor percentage of the total municipal universe. As capital market conditions improved, issuance increased in May and June.
According to analysis by various Fed economists and analysts, the yields on AAA- and AA-rated muni assets have fallen to pre-pandemic levels and are now near all-time lows. Lower-rated securities (BBB and, to a lesser extent, A) nevertheless have higher yields than before the pandemic. As a result, the spread between lower-rated (A and BBB) and higher-rated (AAA and AA) municipal securities is higher than it was in the first half of the year.
During the second quarter, higher-yielding, lower-rated muni debt outperformed higher-rated assets on a credit basis. Long- and short-term maturity bonds underperformed medium-term securities. General obligation bonds underperformed revenue bonds. We endorse electric, water and sewer, and tobacco revenue-based bonds. The worst performers were housing and special tax-backed bonds. Although credit spreads remain wide compared to average levels — especially among lower-rated, high-yield muni debt, led by airline/airport and tobacco bonds — and some bonds still yield more than 100% of Treasury yields, the majority of investment-grade muni cohorts have returned to more normal levels.
Keeping an eye on reserves
Toll highways, subways, bridges, ports, airports, colleges, and convention centers all employ a large portion of the issuance in the municipal market to finance public infrastructure. People must be mobile and able to assemble in order for these businesses to earn revenue. Lack of mobility or drastically reduced public use could have a cascading effect on state and local governments.
The Federal Reserve has stated that short-term interest rates will remain near zero until 2022. If the economy continues to deteriorate, we expect the Fed will review unorthodox policy measures. In the months ahead, the performance of the municipal bond market will be shaped by the strength of this recovery and the rate of normalization. Lower-rated securities have the greatest risk and potential at this time.
A sound market
The municipal bond market has had a tumultuous year in 2020. And, while we expect more pandemic-related volatility, we believe the municipal bond market is robust and that most borrowers will be able to weather the storm. For long-term investors, we believe the muni market is a high-quality market with low default rates and a way for investors to earn tax-free income while diversifying their entire portfolios.
Are municipal bonds now a smart investment?
Municipal bonds have attracted a lot of money from investors looking to decrease risk and taxes. Some investors may be concerned about price drops as the Federal Reserve seeks to raise interest rates. However, muni bonds may see higher coupon rates, and a well-constructed portfolio can still meet long-term objectives, according to financial experts.
In 2021, are municipal bonds a decent investment?
- Municipal bond interest is tax-free in the United States, however there may be state or local taxes, or both.
- Be aware that if you receive Social Security, your bond interest will be recognized as income when determining your Social Security taxable amount. This could result in you owing more money.
- Municipal bond interest rates are often lower than corporate bond interest rates. You must decide which deal offers the best genuine return.
- On the bright side, compared to practically any other investment, highly-rated municipal bonds are often relatively safe. The default rate is quite low.
- Interest rate risk exists with any bond. You’ll be stuck with a bad performer if your money is locked up for 10 or 20 years and interest rates climb.
Why are municipal bonds in decline?
Some economists predict a reduction in muni demand this year due to a predicted slowing in household savings, which grew during the pandemic, particularly among the wealthy. The demand for tax-exempt debt has long outstripped annual issuance.
What will happen to bonds in 2022?
The rate differential between five-year Treasury notes and Treasury Inflation-Protected Securities, or TIPS, is measured by this indicator. This figure is close to the Federal Reserve’s own estimates of 2.6 percent for 2022 and 2.3 percent for the following year.
When can muni bonds be sold?
When interest rates are expected to climb dramatically, this is the most important sell signal in the bond market. Because the value of bonds on the open market is primarily determined by the coupon rates of other bonds, an increase in interest rates will likely lead current bonds – your bonds – to lose value. As additional bonds with higher coupon rates are issued to match the higher national rate, the market price of older bonds with lower coupons will fall to compensate new buyers for their lower interest payments.
When interest rates rise, what happens to municipal bond funds?
The amount you save on income taxes is significantly bigger if you buy municipal bonds after interest rates climb. Long-term gains on investments held for more than a year are subject to capital gains tax rates of up to 20%.
Opportunity cost
Municipal bonds’ tax advantages aren’t as valuable if you’re in a lower tax band as they are if you’re in a higher tax bracket.
If that’s the case, you could be better off putting your money into alternative investments for a larger return.
They may not be liquid
If you need money quickly, you should be aware that municipal bonds may have liquidity problems.
You might not be able to find an active market for your bonds, which means you won’t be able to sell them when you want at the price you want.
