Higher Rates Create New Opportunities in Muni Bonds

As investors rethink fixed income allocations, muni bonds may be entering one of their most compelling periods in years. That was the central message during a recent WisdomTree webinar featuring Kevin Flanagan, head of fixed income strategy at WisdomTree, and Jeff Burger, senior portfolio manager at Insight Investment. The pair argued that higher rates have improved valuations just as investor demand for munis continues to strengthen.

Key Takeaways

Higher Treasury yields have improved municipal bond valuations and created more attractive entry points.
Strong ETF inflows and manageable supply continue to support muni fundamentals.
Active municipal bond ETFs can help advisors deliver tax-efficient income while managing credit and interest-rate risk.

Higher Treasury Yields Create New Opportunities in Muni Bonds

Flanagan opened with a joke about the office hour’s title, Active Muni Strategies For a World Without Rate Cuts. "Maybe the next time we speak it'll be 'a world where the Fed's raising rates,'" he said.

The comment reflected how quickly rate expectations have changed. After the latest Federal Open Market Committee meeting, the 30-year Treasury yield climbed above 5.25%, while the 10-year Treasury briefly approached 4.75%. Against that backdrop, municipal bonds offer advisors an increasingly attractive opportunity for tax-efficient income.

Relative Outperformance Despite July Weakness

Munis did not escape July's rate-driven selloff, but Burger emphasized that investors should focus on relative performance rather than absolute returns.

Municipal yield curves remain considerably steeper than comparable Treasury curves in intermediate maturities. Investors can currently pick up roughly 104 basis points by extending out the municipal curve to around 15 years, versus only about 50 basis points on the Treasury curve. "When you start grossing up the tax-free yields of munis to a taxable equivalent basis," he said, "there was some value created in July."

Strong Muni Bond ETF Inflows Meet Manageable Supply

Perhaps the strongest technical support for muni bonds remains investor demand. Burger described flows into municipal bond ETFs as "truly unprecedented."

While issuance has increased, the headline figures overstate the supply picture. Most of this year's issuance has gone toward refunding outstanding debt rather than financing new projects. New-money issuance has declined year over year, helping keep net supply manageable despite a busier calendar.

Seasonality could also work in investors' favor. September and October typically bring heavier issuance, creating additional opportunities for buyers. Despite munis outperforming other fixed income sectors this year, Burger said, "you can't say this market is overbought."

See More: WisdomTree Office Hours: Unlocking Value in Laddered Munis

How AI Infrastructure Drives Municipal Bond Opportunities

One of the more compelling discussions centered on artificial intelligence and its implications for municipal finance. Rather than focusing on corporate debt issued by hyperscalers, experts highlighted the second-order effects that AI infrastructure could have on municipal issuers. "The biggest implication, as we see it, is really on water and the type of infrastructure that's needed to support these data centers," he emphasized. As communities compete for AI-related development, municipalities may increasingly finance upgrades to water systems, power grids, and other essential infrastructure through revenue bonds. Those projects, he argued, reinforce the importance of dedicated credit research.

Why Revenue Bonds Matter

Throughout the webinar, Burger emphasized Insight's preference for revenue bonds over traditional general obligation (GO) bonds. GO bonds benefit from their simplicity and are often backed by voter-approved taxing authority, but that familiarity can also make them relatively expensive. Revenue bonds require significantly more credit analysis because investors must evaluate the underlying project or enterprise rather than simply relying on a taxing pledge, but institutional research can unlock attractive value.

Why WisdomTree Says "High Income," Not "High Yield"

The conversation concluded with a review of WisdomTree's municipal ETF lineup, including the WisdomTree Core Laddered Municipal Fund (WTMU) and the WisdomTree High Income Municipal Fund (WTMY).

While below-investment-grade munis carry higher credit risk than investment-grade bonds, default rates remain dramatically lower than in the corporate high-yield market. Additionally, municipal issuers also tend to have longer maturities and amortizing debt structures that reduce refinancing risk.

To capture these opportunities, WTMU employs a laddered maturity structure while overweighting carefully selected revenue bonds to enhance yield through active security selection. WTMY builds on that framework by combining an investment-grade ladder with selective allocations to higher-income municipal bonds further out the curve.

Flanagan closed by observing that advisors continue to increase their use of actively managed fixed income solutions in today's uncertain rate environment. Burger agreed, arguing that active management within a disciplined laddered framework may be particularly valuable as interest-rate volatility persists.

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