2024 Municipal Bond Market Outlook: Increased Optimism for the Year Ahead

A year of significant monetary policy tightening is coming to a close.

In the face of a persistently strong US economy, the US Federal Reserve (Fed) had to continue tightening monetary policy throughout most of 2023. A resilient labor market and decelerating inflation supported consumer spending and economic output. In fact, since the economy remains on solid footing while price pressures—though easing—appear to be “sticky,” we believe the Fed will likely prefer to err on the side of caution and keep monetary policy restrictive for longer to ensure a sustained return of inflation to its 2% target.

Going forward, we expect a more constructive backdrop for fixed income investors.

The past year saw heightened levels of volatility across fixed income markets as investors tried to assess the likelihood that the Fed would achieve a “soft landing.” This, in turn, weighed on municipal (muni) bonds, with the sector witnessing significant retail fund outflows. However, it is very likely that the Fed has reached the end of its hiking cycle. We believe that interest rates will now need to remain at or close to current levels for much of 2024 in order to secure a sustained decline in inflation. The good news is that greater certainty around the central bank’s monetary policy should mean less volatility, while declining yields should provide a tailwind for bond investors over the coming year.

A closer look at the muni-bond market.

We remain optimistic about muni bonds going into 2024 and believe that there are opportunities to find value across the credit spectrum.

  1. Technicals have the potential to be constructive for the sector going forward.

Uncertainty around the Fed’s policy rate path and the US economy’s resilience kept investor demand anemic in 2023. However, we understand through anecdotal feedback that asset allocators retain high cash and cash-equivalent balances, waiting on the sidelines for volatility to decline or compelling opportunities to arise. Since muni bonds now offer historically elevated yields, which can be particularly attractive for those investors who target tax-adjusted yields, we expect investor flows to return to this sector going forward. Moreover, the longer-duration nature of the asset class can potentially reduce the reinvestment risk, present with the recently popular money market instruments. A major catalyst that we are looking at for inflows to pick up more significantly is the flattening of the US Treasury yield curve inversion and a return to its more typical upward-sloping shape. A sustained increase in demand should support muni-bond performance over the coming months.