Investors revisit muni bonds amid higher yields and strong credit

It’s been a tough year for municipal bonds, with investors cashing out amid rising interest rates. However, higher yields and strong credit may be sparking a shift, experts say.

While investors piled a record-breaking $96.8 billion of net money into U.S. muni mutual and exchange-traded funds in 2021, weekly inflows have been negative for most of 2022, according to Refinitiv Lipper data.

Last week’s numbers were still negative, but outflows slowed significantly, signaling more interest, according to Tom Kozlik, head of municipal research and analytics at HilltopSecurities. 

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One of the reasons may be a higher so-called municipal-Treasury ratio, comparing muni bonds and nearly risk-free Treasury yields, explained Kozlik. The higher the percentage, the more attractive muni bonds become.

“I’m not necessarily saying we’re going to see a complete turnaround in the next week or two,” he said. “But we are going to see bits of strengthened demand through the summer.”

With many muni bonds maturing in June and July, he expects investors to roll their money back into these assets, contributing to positive inflows. 

A popular asset for higher earners, muni bonds generally avoid federal taxes on interest and may skirt state and local levies, depending on where you live.

“I think that public finance upgrades will outpace downgrades in 2022,” said Kozlik, pointing to “very strong” credit ratings.

Indeed, many states are still flush with cash with larger-than-expected tax revenue during the pandemic and $195.3 billion in federal support from the American Rescue Plan.

However, it’s still too early to predict states’ financial strength for 2023, Kozlik said.