US municipal bonds: Finding investment opportunities

A unique opportunity is unfolding in the municipal bond market. Recently, yields on these bonds have risen, driven by general market uncertainty and concerns about their tax-exempt status. Despite discussions in Washington about potentially taxing municipal bond interest to boost government revenue, we believe this interest will remain tax-exempt. This tax advantage, along with the current yield environment, makes municipal bonds a valuable component of a diversified investment portfolio.

Municipal bonds typically offer interest income that is exempt from federal, state and local taxes, making them especially appealing to investors in higher tax brackets. These bonds are attractive not only for their high yields but also because they offer better returns compared to U.S. Treasuries. The 2-year and 5-year municipal bonds are particularly appealing based on historical performance.

Additionally, the gap between the 10-year AAA municipal bond yields and expected inflation over the next decade is the widest it has been since 2010. This indicates that the 'real yield' on a 10-year municipal bond is among the highest in the past 15 years.

In conclusion, municipal bonds present a rare opportunity for investors seeking tax-efficient income and portfolio diversification. The current yield environment, coupled with the likely continuation of their tax-exempt status, makes municipal bonds an attractive option for enhancing a fixed-income strategy. They offer a way to increase yield without sacrificing quality, making them a smart choice in today's market.

All market and economic data as of 04/28/25 are sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

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