Though low yields and rising inflation are turning some investors away from fixed income, 2021 is shaping up to be a potentially strong year for municipal bonds.
Long seen as a sleepier, even boring side of fixed-income markets, the municipal bond space is heating up, thanks in part to the ambitious tax proposals being put forth, said Jeff Timlin, head of municipal bond investing at Sage Advisory.
“Once Biden got elected, we knew that the talk of higher tax rates—obviously, higher federal taxes, but higher taxes across the board with both individuals and corporations—would be a positive for municipal bonds from a demand standpoint,” said Timlin. “With higher yields creeping in slowly, the desire for income and tax-free income in particular is going to be more attractive despite some of the price losses bond investors have seen.”
But there are other reasons the municipal market is looking stronger in 2021—one being the massive $1.9 trillion stimulus package passed and signed in early March. That bill provided $500 billion in direct aid for state and local governments, which Timlin said helps to solidify municipals from a credit perspective.
While prior Covid-19 relief bills did not provide such a large injection of aid to governments, Timlin argued that the need didn’t exist.
“When we look at the two stimulus deals that came last year, we still ended up having a budget deficit across all 50 states and local governments totaling an additional $7.6 billion relative to 2019,” said Timlin. “In the long run, that looks like more of a rounding error or normal, minor slowdown. Thus, the most recent deal is what we would consider stimulus rather than budgetary support.”
Also adding to the strength of the municipals market is the potential for infrastructure spending, said Timlin. President Joe Biden addressed both houses of Congress on Wednesday in part to lobby for $2.2 trillion in infrastructure spending, taking an expansive view on the definition of infrastructure.
The areas of infrastructure most additive to the strength of the municipal bond market, according to Timlin, are the ones focued on transportation spending.
“In our opinion, this is more of a low probability event over the next year or two as the administration deals with the effects of Covid-19,” said Timlin.
Without Taxes And Stimulus
Municipals might be gaining in attractiveness even without a boost from policy makers, said Timlin.
For one thing, liquidity in the municipal market has improved with more bidders seeking issuances in blocks of one million bonds or less.
“Historically, anything that has traded in sub-million bond blocks has experienced a larger bid-ask spread, but today there’s a tremendous amount of demand among retail traders for sub-million paper and sub-hundred-thousand paper that rarely got attention previously,” Timlin said.