Pacific Investment Management Co. reportedly expects municipal debt to offer a bond-market haven from rising interest rates.
U.S. government debt has lost 1.3% this week, on track for its worst stretch since 2020, while munis have only dropped 0.2%, Bloomberg index data show.
The municipal market has a history of outperforming during periods when the Fed hikes rates, David Hammer, head of municipal-bond portfolio management for the firm, told Bloomberg.
The portfolio oversees more than $76 billion in state and local government debt.
Hammer said that as yields rise, the tax-free interest that munis pay makes them more attractive.
“It’s this dynamic that historically has caused tax-exempt muni spreads to tighten relative to other taxable fixed-income investments as rates rise,” he said. “The muni market has a long history of outperforming as interest rates rise.”
For Hammer, junk-rated munis have also outperformed when rates rise. That segment of the muni market is benefiting from improving credit conditions for issuers, which has kept defaults low. It also offers elevated yields compared to high-yield corporate bonds after accounting for taxes, he said.
“High-yield munis still look attractive,” Hammer said. “We see this as a defensive position if the economy was to disappoint.”
Hammer favors structures like floating-rate notes, a type of short-term debt with a coupon that is benchmarked off short-term indexes like the SIFMA Municipal Swap index