Bonds: Munis
The municipal bond market experienced fluctuations in 2024, with tax-free yields rising in response to Treasury yield movements, particularly in the latter half of the year. Market uncertainty increased following the Federal Reserve’s December rate cut, which coincided with ongoing inflation concerns and economic crosscurrents.
As 2025 begins, the potential extension of 2017 tax cuts under the new administration may impact demand for tax-free bonds, particularly if corporate tax rates are lowered. Climate-related risks, such as the LA fires and hurricanes, have drawn attention to municipal finance, with increased insurance costs and resilience measures potentially leading to more bond issuance.
Despite these pressures, municipal credit quality remains stable, supported by strong reserves, prudent budget management, and infrastructure reinvestment. However, challenges persist in certain sectors, including healthcare, higher education, and public K-12 schools, due to shifting demographics, rising costs, and expiring pandemic aid.
Finsum: These are important things to monitor for municipal bonds, and the increasing role of DOGE, could drastically change this bond segment.
Municipal bonds, often overlooked, are gaining attention as fixed income performs strongly, prompting investors to reconsider their portfolios for 2025. Gregory Steier from Brown Brothers Harriman, highlighted that with elevated yields and record municipal issuance, risks are relatively low, making this an exciting time for munis.
Steier emphasized that, for 2025, high-quality municipal portfolios might even outperform equities. Munis are attractive for their liquidity, income, diversification, and tax efficiency, with national muni bonds offering advantages over state-specific ones.
Investors can access municipal exposure through ETFs like the ALPS Intermediate Municipal Bond ETF (MNBD), which focuses on bonds exempt from federal taxes, offering an active approach and strong returns, outperforming its benchmark.
Finsum: This strategy could be a compelling option for those seeking solid yields to kick off the new year.
Franklin Templeton is optimistic about fixed income in the coming year due to the Federal Reserve ending its hiking cycle, and inflation continuing to trend lower. However, it believes that rates will remain at these levels for much of 2024 in order for inflation to fall to the Fed’s desired level, leading to a more challenging environment in the first-half of the year.
Amid this backdrop, the firm is bullish on municipal bonds especially with so many investors on the sidelines, overweight cash, or in short-term credit. Municipal bonds offer historically attractive yields, favorable tax treatment, and a longer-duration which should outperform in an environment with falling rates and a flattening yield curve.
The firm notes that local governments remain in strong shape from a fiscal perspective even despite a slowdown in economic activity and rising costs. Many still have excess funds leftover from federal aid during the pandemic and have been relatively disciplined in terms of spending. Further, muni bonds have lower default rates than corporate credit while also having higher after-tax returns. Franklin Templeton believes many investors will reallocate from money markets into municipal bonds in order to lock in yields at these levels especially as monetary policy eases.
Finsum: Franklin Templeton is bullish on fixed income in the coming year. It also highlights a bullish case for municipal bonds due to the sector’s strong fundamentals and favorable positioning in this macro environment.
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Goldman Sachs Asset Management recently launched the Goldman Sachs Community Municipal Bond ETF (GMUN). The ETF, which trades on the NYSE Arca, seeks to provide investment results that closely correspond, before fees and expenses, to the performance of the Bloomberg Goldman Sachs Community Municipal Index, a rules-based index designed to track the municipal securities market with remaining maturities between one and 15 years. The ETF also has screens that consider certain social or environmental factors. By focusing on 1-to-15-year maturities within the investment grade municipal bond universe, the portfolio will seek to deliver diversified market exposure with lower duration and higher credit quality than the broader municipal market. The ETF is managed by Goldman’s Municipal Fixed Income team which brings decades of experience with an active and disciplined approach to investing in a market that is vast and fragmented. The fund has an expense ratio of 0.25%. According to Goldman, targeted allocation into municipalities and projects with positive impact will provide the opportunity to invest in education, healthcare, clean energy, and more community-related initiatives.
Finsum:Goldman recently launched its first muni ETF, the Goldman Sachs Community Municipal Bond ETF (GMUN), which provides exposure to tax-exempt municipal securities with remaining maturities between one and 15 years.
Vanguard recently expanded its tax-exempt bond ETF lineup with the launch of the Vanguard Short-Term Tax-Exempt Bond ETF (VTES), which is built to help investors earn consistent, tax-exempt income. The fund’s objective is to track the performance of the S&P 0-7 Year National AMT-Free Municipal Bond Index using a sampling technique to closely match key benchmark characteristics. The index measures the investment-grade segment of the U.S. municipal bond market with maturities between one month and 7 years. This is Vanguard’s first US-listed ETF launch in nearly two years. The ETF, which is managed by Vanguard Fixed Income Group, has been listed on NYSE Arca with an expense ratio of 0.07%. Sara Devereux, Global Head of Vanguard Fixed Income Group had this to say about the launch, “The Vanguard Short-Term Tax-Exempt Bond ETF is built to optimize tax efficiency for investors seeking to allocate to the shorter end of the municipal bond market. The new ETF complements our broad fixed income line-up and provides clients with another avenue to tap our municipal bond team’s talent and capabilities.”
Finsum:Vanguard expanded its tax-exempt bond ETF lineup with the launch of the Vanguard Short-Term Tax-Exempt Bond ETF (VTES), its first US-listed ETF launch in nearly two years.
According to Vanguard, investors that allocated part of their portfolios to low-yielding municipal bonds at the beginning of last year should now be looking forward to the prospect of higher income, thanks to a rapid rise in rates. In a fixed-income report for the first quarter, the fund firm wrote, “Following a year with $119 billion of outflows from municipal funds and ETFs, we expect the tide to turn. For high-income taxable investors, we are expecting a municipal bond renaissance.” According to the report, muni bonds only offered yields of around 1% at the start of 2022, compared to yields that now exceed 3% before adjusting for tax benefits. Tax-equivalent yields are at 6% or even “meaningfully higher for residents in high-tax states who invest in corresponding state funds.” Vanguard said that this makes munis a “great value compared with other fixed income sectors and potentially even equities—especially with the odds of a recession increasing.” According to the Vanguard report, muni bonds also remain strong from a credit perspective, with attractive spreads over comparable U.S. Treasurys and corporate debt. In fact, municipal balance sheets are stronger now than they’ve been in two decades, leaving states well-prepared to navigate an economic slowdown.
Finsum:According to Vanguard, higher yields and solid balance sheets make muni bonds a highly attractive option for investors this year.