Munis: A Historically Defensive Asset Class During Economic Downturns

Posted by Lawrence Gillum, CFA, Fixed Income Strategist

Tuesday, November 29, 2022

With the Federal Reserve (Fed) embarking on the most aggressive rate hiking campaign since the 1980s, the risks of an economic slowdown have increased. With inflationary pressures continuing to run hotter than the Fed would like, many Fed officials have stated they are willing to continue to keep increasing interest rates—even to the point of sacrificing economic growth—in order to get aggregate demand and aggregate supply back in balance. Although the timing of when interest rates will peak—and its effect on certain asset classes—is uncertain, the Fed’s tight monetary policy is already having an impact on the most sensitive areas of the economy, such as housing and consumer spending. And with less consumer spending, the outlook for corporate borrowers may be challenged in the near term. Muni bonds, however, have proven to be resilient in challenging economic times.

Shown below, is the default rate of muni securities versus their corporate counterparts. As shown, the annual default rate for muni securities (blue line), in aggregate, is significantly below what has historically occurred in the corporate credit markets (grey line). Additionally, muni defaults during economic contractions (grey shaded region) have been relatively benign. According to Moody’s Investors Service, a rating agency, the average five-year municipal default rate between 1970 and 2020 was just 0.08%, which compares to an average five-year corporate default rate of 6.9% over the same period.

View enlarged chart

Muni bonds are having their best month in decades as signs of inflationary pressures are easing. Muni debt has gained 4.3% in November (through 11/28), on track for the biggest monthly advance since August 1986. The rally has pared the muni market’s loss this year to 9.1%, which would be the largest annual drop since 1981. With the influx of pandemic-related stimulus money, healthy tax collections, and prudent savings practices, we think the fundamental back drop for many borrowers remains strong. And with the risk of recession increasing, muni securities could be a good area to weather an economic storm.


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