By Chad Roope, CFA ®, Chief Investment Officer

U.S. municipal bonds (munis) are prized for their tax advantages, but their historic tendency to provide a stable source of return also makes them valuable amid market volatility and uncertainty. Munis are generally less vulnerable to inflation shocks or the crossfire of global trade policies because they are often linked to public authorities that provide fee-based essential services, such as waste collection and public transportation, or secured by taxes on sales, property, and income. Munis have also shown historically low default rates and high credit ratings (Aa3 versus Ba1 for global corporate debt, on average) thanks to the disciplined finances and stable revenues of most state and local governments. Tax equivalent yields of munis have reset to levels not seen in over a decade, with some investment grade yields north of 6%. Against this backdrop, we see an opportunity to increase allocations, particularly as the outlook for limited supply relative to demand in July and August could bolster performance.

Additionally, munis offer a possible antidote to tariffs and recession concerns. Amid Wall Street’s growing concern over a potential tariff-induced recession, investors are seeking refuge in areas least affected by global supply chains. This is fueling interest in state and local government bonds for the following reasons:

• Limited exposure to trade risks: A broad-based economic slowdown would reduce state revenues, but, as a service-centered economy, we believe the U.S. is less vulnerable to trade volatility despite significant exposure to trade in automobiles, agriculture, and petrochemicals. Among the 50 states, the median gross trade-to-GDP ratio with China — which poses the greatest tariff risk — is just 1.4%, with Tennessee having the highest ratio at 4.6%. Only a few states have total economic debt (debt + unfunded retirement benefits) to GDP ratios of more than 20%. This compares favorably to other sovereign and sub-sovereign debt issuers around the world.
• Built-in Inflation buffers: States rely heavily on federal transfers to fund programs such as Medicaid, but their main funding sources are sales and income taxes. In fact, more than 70% of state General Fund revenues, which fund core state operations and state aid to local school districts, are derived from sales and personal income, linking them broadly to economic performance but not to specific trade actions or federal budget discussions. Because states depend more on broad economic activity than trade, state finances benefit from built-in inflation protections as tax revenues rise proportionally with wages and prices.
• Rising local tax revenue: Property taxes, which are based on the assessed value of real estate, are the main source of revenue for local governments. National home prices have had steady annual gains, including 4.5% in 2024, appreciating each quarter since the start of 2012.
• Resilient state balance sheets: States are the largest issuers of municipal debt and possess sovereign powers that allow them to levy taxes and pass costs onto their municipalities. Unlike the federal government, states cannot run deficits through debt issuance. In fact, 46 of the 50 states have constitutional balanced budget requirements. Over the past decade, state balance sheets have steadily improved due to increased reserves and reduced debt, providing resilience in the face of a potential economic slowdown.

For high-tax-bracket investors, we believe municipal bonds’ long-term record of stable return provides a unique opportunity to enhance portfolio resilience in what is likely to remain a less-than-stable macro environment. Their attractive yields relative to taxable counterparts and potential ballast to equity risk make munis particularly compelling with a favorable supply/demand picture in the summer months setting the stage for strong performance.

Source: BlackRock Q3 2025 Fixed Income Outlook