In today’s uncertain market, characterized at its advent by a shift in central bank policy and a potential slowdown in the U.S. economy, demand for high-quality credit is likely to remain elevated.
In this environment, taxable U.S. municipal bonds offer investors a complementary option to traditional investment grade corporates.
Their income advantages and reduced volatility make taxable munis prudent for investors navigating a challenging economic landscape.
Income advantage of taxable municipal bonds
December 2019–November 2023
Source: Bloomberg, Principal Fixed Income. Data as of November 30, 2023.
The late 2023 rebound in U.S. financial assets was largely driven by money returning to fixed income, which had experienced fluctuating demand to that point.
Still, in early 2024, despite investment grade (IG) credit spreads at very tight levels, the fundamental and technical picture remains quite compelling.
In even a mild economic slowdown, IG credit should outperform lower-quality credit, and taxable U.S. municipal bonds are emerging as a complementary option for investors looking to increase overall IG allocations.
Though taxable municipal bonds performed on par with IG credit in 2023, delivering returns of 8.84% and 8.52%, respectively, taxable municipal spreads still provide an income advantage compared to similar maturity corporates.1
Ten-year taxable municipal spreads are wider than AA-rated corporate spreads while yielding about the same as A-rated corporate spreads.
Taxable municipals are also attractive for their lower correlation to riskier assets like high-yield credit and equities, and their reduced volatility.
The Bloomberg Taxable Municipal Index’s 360-day spread volatility was only 18.1%, compared to the 27.8% of the Bloomberg U.S. Corporate Investment Grade Bond Index.2
Despite narrower spreads than last year, IG credit should provide continued value in 2024 due to diversification benefits and ongoing demand for high-quality, long-duration assets.
Coupled with the higher credit ratings of the asset class, the yield and volatility advantages of taxable municipal bonds should catch the eye of stability-seeking investors ahead of a prospective slowdown.
1Return figures are as of December 31, 2023 and reflect the Bloomberg Taxable Municipal Bond Index and the Bloomberg U.S. Corporate Investment Grade Bond Index.
2 As of December 18, 2023.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.