Municipal bonds are widely regarded as an attractive investment opportunity at present, with several factors aligning to create a favorable risk-reward profile and entry point for investors.
Broader market volatility, including concerns over tariffs and policy uncertainty, has led to increased volatility in municipal yields. Large redemptions from municipal ETFs and funds have also contributed to price swings and higher yields.
After a recent sell-off, municipal bond yields are well above their five-year averages. Intermediate municipal bonds yield close to 4%, with long-term bonds offering levels near 5% – especially attractive when considering their tax-exempt status. Municipal-to-treasury yield ratios are also at their most favorable levels in years, with the 10-year ratio at 78% and the 30-year ratio at 92%, both significantly above historical norms, indicating that municipals are relatively inexpensive compared to Treasuries. The interest from municipal bonds remains exempt from federal income tax and often from state and local taxes if you buy bonds from your home state. For high-income investors, the tax-equivalent yield can be substantially higher than that of taxable bonds.
In early 2025, municipal bonds have lagged behind other fixed-income sectors due to factors such as heightened supply and heightened selling during tax season, resulting in their relative value based on historical benchmarks. The issuance of municipal bonds has seen a significant increase, with a 15% rise in the first quarter of 2025 compared to the same period in the previous year. This surge in supply has overshadowed demand, exerting downward pressure on prices and leading to higher yields. Overall, state and local governments remain in strong financial standing, with ample reserves and solid credit ratings, which makes municipal bonds a comparatively safe investment option despite economic uncertainties.
Risks to Watch:
Potential changes to the tax-exempt status of municipal bonds have been discussed in policy circles, but most experts view this as a low-probability event in the near term.
Municipal bonds have recently underperformed other bonds due to technical and supply-driven factors, so some volatility may persist in the short term.
Conclusion
Municipal bonds offer higher, tax-advantaged yields, attractive valuations, and solid credit quality, making them a worthwhile investment for individuals in higher tax brackets. However, this opportunity may not last as market conditions stabilize and yields might decrease. Over the last 15 years, most of the total returns from municipal bonds have come from income rather than price increases, highlighting the importance of securing higher yields whenever possible. Muni-bond issuers are supported by a diverse range of revenue sources, including income, real estate and sales taxes, healthcare costs, university tuition, water and sewer fees, and toll expenses and will likely hold up well within the range of possible future scenarios as they are generally all essential costs that people continue to pay even during periods of economic slowdown. Additionally, municipal bonds are a domestic asset class and are relatively insulated from the effects of tariffs.