Municipals Thoughts from the Municipal Bond Desk

Tim: Defaults are down in 2026. Does that support our view that credit fundamentals continue to be resilient?

Mark: I think so! When you look at the numbers, the story is really encouraging. First-time payment defaults in March totaled just $49.5 million, which shows a sharp 79% year-over-year decline.¹ And those defaults were concentrated in a single borrower.¹ The March number also means that year-to-date defaults are rather low at $257.2 million — a 70% drop year over year.¹ Looking ahead, I expect defaults to remain low and mostly limited to sectors experiencing unique challenges. These are areas such as nursing homes and senior living, hospitals, industrial development, and some education sectors.¹ That said, even within these sectors, there are many healthy credits, which is why thorough, bottom-up research is so important. The fact that there have been no Chapter 9 bankruptcy filings so far this year¹ further supports our view that overall credit conditions remain solid, even though there may be occasional problem spots. On balance, I think munis continue to offer a very compelling credit picture heading into the second half of the year.

Tim: What are the implications for interest rates and inflation if we see a prolonged conflict in the Middle East?

Mark: Great question, and it’s one we’re watching very closely. The conflict has already had a direct impact on financial markets, raising inflation expectations and pushing interest rates higher. Rising energy prices have increased breakeven inflation rates across world economies,² which has contributed to increased interest rate volatility. But while global financial conditions have tightened, I don’t see evidence of acute liquidity stress. The longer-term impact on economic growth, however, remains unknown. I’ll say that elevated inflation pressures could force central banks to tighten monetary policy. On the other hand, I believe an extended conflict is likely to weigh on economic growth and labor markets, which could preclude central bank tightening. The bottom line is that central banks are in a difficult position, and investors should be prepared for a wider range of rate outcomes than we’ve seen in recent quarters.

Tim: Investment flows turned negative recently. Was this mainly due to seasonal pressures, as investors looked to pay their tax bills?

Mark: Yes, that’s exactly right. Consistent with historical patterns, outflows increased as investors made withdrawals to pay tax liabilities. Certain investors may also have been taking advantage of the opportunity to do some tax-loss harvesting, given that muni yields have risen. On April 13 alone, the muni market experienced $319 million in net outflows, driven largely by $243 million in withdrawals from muni ETFs. Not surprisingly, significant redemptions also came from ultrashort duration strategies.³ Tax‑exempt money market funds, for example, posted a fifth consecutive day of withdrawals, totaling $3.8 billion, on April 13.³ That said, I think the tax-driven selling may be creating attractive entry points for investors seeking tax‑efficient cash and short‑duration exposure. We’ve seen this pattern before, and historically these seasonal dislocations tend to reverse once tax season passes, so patient investors could be well rewarded here.

Read the complete article, including munis by the numbers.