Municipal Bonds Positioned to Shine in 2023

On a recent webinar, Michael Cohick, Director of Product Management, and Tamara Lowin, Senior Municipal Credit Analyst, shared their outlook for municipal bonds in 2023. Highlights from their discussion are below.

Darkest Before the Dawn: A Bright Outlook for Municipal Bonds

Along with other fixed income asset classes, 2022 was a rough year for municipal bonds. However, yields are now higher for muni bonds than at any other time in the past 15 years. And dating back to 1989, a down year in the municipal bond market has been followed by at least one year (or several) of positive returns.

Strong Recovery Historically Followed Down Years for Investment Grade Municipal Bonds

Source: ICE Data Services. As of 12/31/22. Based on the ICE US Broad Municipal Index, which tracks the performance of U.S. dollar denominated investment grade tax-exempt debt publicly issued by U.S. states and territories, and their political subdivisions, in the U.S. domestic market. You cannot invest directly in an index. Past performance is not a guarantee of future results.

Muni Bond Default Rates Low and UnLikely to Substantially Increase in 2023

Low default rates are a hallmark of the municipal bond asset class. This was reaffirmed in Moody’s Investors Service’s annual municipal bond market snapshot, U.S. municipal bond defaults, and recoveries, 1970-2021, with updates through 2021. In more good news for muni investors, the report noted that the sector continued to recover from the effects of COVID-19. State tax revenue has recovered and is now higher than its pre-pandemic trajectory.

In addition, while they may have become more common over the past 15 years, municipal defaults and bankruptcies remain rare overall. In fact, there were no new rated municipal bond defaults during the period of significant market stress in 2021 resulting from COVID.

Municipal Bond Defaults Remain Muted

Source: Municipal Market Analytics, as of 12/31/22. Past performance is not a guarantee of future results.

Favorable Supply/Demand Backdrop

In 2022 we saw massive outflows from the muni space and severely muted supply. However, in the current environment, demand for tax-exempt income is expected to outpace the supply of new municipal issuance. This supply constraint may increase the likelihood of solid performance in 2023.

Looking ahead, we believe the long-term prospects of municipal bonds remain compelling. The eventual return of municipal market performance is likely indisputable; the only question is when. While we await dawn, the favorable market backdrop keeps us warm.