2021 Municipal Outlook: Reasons for Optimism

After 2020, a year for the ages, 2021 should bring a mixed bag for the muni market. We expect rates and yields to increase moderately during the year, and munis to remain as resilient as ever, offering select opportunities for active investors.

Despite 2020’s many challenges, the Bloomberg Barclays Municipal Bond Index was up 5.2%, with returns that were even more compelling for the second half of the year, across the credit spectrum (Display).

Muni bond returns May 1 to December 31, 2020 are as follows: Triple-A, 5.4%, A, 8.6%, Triple-B, 13.7% and High Yield, 16.6%.

Going forward, favorable conditions should help munis continue to perform well, including helpful monetary and COVID-19 stimulus, ongoing vaccine distribution, better-than-expected tax collections, and a beneficial muni supply picture.

Stimulus and Vaccines Bode Well for Munis

Supportive federal stimulus will likely continue in 2021, keeping the fed funds rate at zero and quantitative easing (QE) in place. The Federal Reserve (Fed) is currently buying $120 billion in securities monthly, split between US Treasuries and mortgage securities. Assuming the Fed stays its course, QE will likely restrain yields from rising to a level that makes the central bank uncomfortable, so we expect any increases in 10-year US Treasury yields to be moderate.

The passage of a $900 billion fiscal stimulus package should help jump-start the US economy. Now that Democrats are the controlling party, more stimulus is expected, and it likely will directly benefit states and municipalities. Moreover, the Democrats’ slim majority puts President-Elect Biden’s proposal for higher taxes in closer reach. If achieved, a higher top marginal tax rate for both individuals and corporations would increase demand for tax-exempt municipal bonds.

Finally, with more COVID-19 vaccines being distributed, a return to normalcy is closer, along with further improvements in employment and tax collections. Although there is still some wood to chop, an extended recovery should lay solid groundwork for continued improvement in municipal credit.