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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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Past performance is not a guarantee or a reliable indicator of future results. All references to performance are based on index data as of 30 September 2015. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. High-yield, lower-rated, securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Investors will, at times, incur a tax liability. Income from municipal bonds may be subject to state and local taxes and at times the alternative minimum tax. Equities may decline in value due to both real and perceived general market, economic, and industry conditions. PIMCO does not provide legal or tax advice. Please consult your tax and/or legal counsel for specific tax or legal questions and concerns.

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