Rising Rates and Municipal Bonds

Municipals’ tax-exempt income stream should become increasingly attractive as interest rates gradually rise.

David Hammer and Erin Leighty explain why in a rising rate environment, municipals should perform relatively well.

Municipals have tended to outperform most other areas of fixed income in rising rate periods, and we think this tightening cycle will be no exception.

  • As Fed policy becomes gradually less accommodative, investors should look for more of their total return from income. The benefit of munis is that the income comes in tax-exempt* form. As rates rise, the after-tax benefit of munis becomes greater.
  • Municipal supply often softens in a higher interest rate environment, as issuers are less likely to re-finance municipal debt. Therefore, rising interest rates can have a virtuous effect on the municipal market.

*Tax exemption refers to federal taxes. Income from municipal bonds may be subject to state and local taxes and at times the alternative minimum tax. Taxable-equivalent municipal bond returns are determined using an effective rate of 46.77%, incorporating the effect of an average state income tax of 5.58%

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