Muni Bond Update: What’s next for tax-exempt bonds?

Text on screen: PIMCO

Hammer: We've seen a large divergence this year in fixed income market performance, taxable fixed income.

Text on screen: Dave Hammer, Portfolio Manager

The Barclays AGG, up about four and three quarters percent. The IG Muni bond index is about flat on the year.

We've been asked by many clients what our outlook is for munis today and where we see opportunities for the remainder of the year.

Well, first, why munis underperform. It's largely due to technical factors.

Text on screen: 2025 sees record issuance

[ADA text] Chart compares average gross and monthly 2025 issuance (in billions) from January to August (higher each month in 2025).

Muni issuers rush to market in front of the OB three bill. Fearful that they may lose access to issuing more tax exempt debt. So we've seen record supply through the first eight months of the year, limited inflows back into the market. Only about half of the money that left in 2022 as rates rose has come back into the market. And then of course, we see very tight corporate credit spreads, in other markets. So it's exacerbated, this performance dispersion.

Thinking today, how do we view, the muni market on a go forward basis?

Text on screen: Muni curve is exceptionally steep today

[ADA text] Chart shows steeper yield curve for AAA muni bonds versus Treasury bonds, indicating higher yields for longer maturities.

Well, the Muni curve is exceptionally steep today. About 145 basis points of spread between 10s and 30s. That's about double the Treasury market, short to intermediate maturities that we've used about fair value. There's been good consistent buying there from separately managed account strategies that are programmatically reinvesting.

The long end is quite cheap. Today, simple yields on high quality Muni bonds are about four and a half to 5% tax free. That's about 100% of treasuries.

An investor would have to earn somewhere between seven and a half and 9% pretax and get the same after tax return, which away from munis today means taking a lot more risk. There are areas to avoid and specific opportunities.

Images on screen: Smaller hospitals and universities.

I'd start with health care and higher education. Both are facing headwinds. Health care in particular due to Medicaid cuts. Profit margins are still under pressure.

And then the other are more speculative deals. Large, not rated issues that were sold to high yield municipal bond funds between 2016 and 2021 during an era of low yields. We see many of those deals struggling, in an era of higher rates.

Images on screen: PIMCO trade floor

And the best opportunities we see today are to take advantage of that cheapening of the long end in the municipal market.

in the long end of the curve, where investors can own an A-rated or AA rated Muni bond somewhere between four and a half and 5% tax free, and expect to earn not just the simple yield, but also some role down in carrier or price appreciation.

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Performance results for certain charts and graphs may be limited by date ranges specified on those charts and graphs; different time periods may produce different results. Charts are provided for illustrative purposes and are not indicative of the past or future performance of any PIMCO product. The terms “cheap” and “rich” as used herein generally refer to a security or asset class that is deemed to be substantially under- or overpriced compared to both its historical average as well as to the investment manager’s future expectations. There is no guarantee of future results or that a security’s valuation will ensure a profit or protect against a loss.

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