As interest rates and credit conditions continue to evolve, investors are naturally asking: Where is the best opportunity for income in the fixed-income market today? For clients in higher tax brackets, understanding the relative value of municipal bonds, corporate bonds, Treasuries, and the broader fixed income market is essential.
We regularly analyze these benchmarks to help our clients make informed, tax-efficient investment decisions. Here’s a snapshot of the current landscape.
Municipal bonds remain attractive to high-income investors because their yields are generally exempt from Federal taxes. In addition, investing in a municipal bond issued in the state in which you file becomes even more attractive for high-income earners as in-state issues are generally exempt from Federal and State income taxes. A few examples of high-income tax states include New York, New Jersey, California, D.C., Hawaii, etc.
The credit quality of the U.S. municipal bond market remains robust, backed by strong state and local government fiscal health and historically low default rates. A few highlights:
- States maintain near-record rainy day funds: Following solid tax revenue growth, many states and local governments have amassed significant cash reserves. The median state rainy day fund balance was around 13% of general fund spending in late 2024, compared to just 1.8% after the 2008 financial crisis.
- High average credit rating: With a low historical default rate, the U.S. municipal bond market has an average credit rating of AA, the same as the U.S. federal government. In 2024, upgrades for municipal debt outpaced downgrades by more than 2-to-1.
- Low default rates: Within the municipal market, rated investment-grade bonds have seen extremely few defaults. For the 53-year period ending in 2022, the cumulative default rate for investment-grade municipal bonds was 0.08%, while for corporates it was 6.9%.
- Resilience through downturns: Municipal bonds have historically shown resilience during recessions and other market turmoil. One Moody’s report notes that government support has often helped keep essential services, like hospitals, from defaulting, even during tough times.
For high-income earners, municipal bonds continue to offer compelling after-tax yield, with strong credit fundamentals and moderate interest-rate sensitivity. Strategically incorporating municipal bonds into a fixed-income allocation can enhance portfolio tax efficiency while managing credit and duration risks.
As always, please consult with your financial and tax advisors. In many instances, a diversified approach can make sense in order to balance duration, credit quality, interest-rate sensitivity, etc. Feel free to reach out to one of our wealth advisors if you’d like to learn more.
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