July 07, 2022
This year, yields have adjusted dramatically higher due to selling pressure in the
municipal bond market against the backdrop of rising interest rates. We think
current high municipal yields may offer an attractive entry point for investors seeking
tax-adjusted income.
The value proposition for municipal bonds appears notably more attractive when
considering the taxable-equivalent yield. For example, at the top US federal income tax bracket 40.8%, a
30-year AA-rated New York municipal bond’s taxable-equivalent yield is 6.67%, but at the
22% tax bracket (not shown in the chart), that taxable-equivalent yield would still be
an attractive 5.06%.
Taxable-equivalent yield on a municipal bond versus taxable alternatives
for top US federal income tax bracket
As of June 6, 2022
* Taxable-equivalent yield is determined by taking the yield of a tax-exempt bond and dividing it by 1 minus an
investor’s federal income tax bracket. For this chart, a 40.8% tax bracket is used (37% federal income tax + 3.8%
Medicare tax), so 3.95% divided by (100% – 40.8%) = 6.67%.
Source: Bloomberg, as of June 6, 2022.
Chart is for illustrative purposes only
What this means for investors
Year to date, municipal bond yields have risen more and their AAA-rated yield curve has steepened more than that of Treasurys. Given this environment, we think municipal bonds, appear more attractive versus other fixed income options, even before applying the tax benefits.
Exploring investment opportunities in municipal bonds may make sense for today’s income investors, not just those in the highest tax brackets.
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