Anya Dalal

What’s Driving Interest Rates Higher? Oil

Where is the Opportunity? Munis

The fixed-income market is experiencing a rare, time-sensitive window of opportunity for investors. As global capital markets transition through a cooling economic cycle and a changing monetary policy environment, history shows that opportunities to capture historically high yields in traditionally lower risk municipal bonds can vanish rapidly. For high-net-worth investors, acting quickly to lock in tax-free cash flow, at levels seen only on select occasions over the past twenty years could increase after-tax cash flow levels for decades to come.

• Oil is the primary driver: If anyone wants to know what has been driving interest rates higher in the US and around the globe, the answer is very straightforward: higher oil prices. The correlation between the price of oil and US Treasury yields is over 90% over the past three months, according to Bloomberg. The breaking news here is that it is not budget deficits or the US government’s growing level of outstanding debt driving interest rates higher. Instead, the higher price of energy has been the primary catalyst pushing rates up around the world.
• Historic 8% to 10% Taxable-Equivalent Yields¹: High-grade and high-yield municipal bonds are currently generating some of the most compelling taxable-equivalent yields (TEY) observed in the post-pandemic era. For investors in the highest tax brackets, especially when factoring in combined federal, state, and local taxes, nominal, taxable-equivalent Muni yields equate to historical equity-like returns of 8% to 10%, without exposure to equity, corporate, or private credit risks.
• A Shrinking Window for Peak Income: This highly unusual pricing anomaly represents a rare dislocation in the yield curve and broad fixed-income complex. As the broader macroeconomic cycle continues its shift, these high-income opportunities could vanish as quickly as they came, should oil prices decline, exerting downward pressure on inflation. What we know is that higher oil prices and corresponding higher interest rates are demand destroyers, not catalysts for faster economic growth.
• Locking In Fixed-Rate Protections Now: Investors have the opportunity to increase after-tax, fixed cash flow, preserving a predictable income stream for potentially decades to come, while positioning their portfolio for potentially significant capital appreciation, should rates drift lower over time, as is our expectation.
• Maximum Insulation from Tax Erosion: For investors residing in the highest tax brackets, the structural tax exemption of municipal securities offers immediate relief. It prevents the heavy tax drag that typically erodes fully taxable alternative investments, ensuring more cash flow stays in the portfolio.
• Unmatched Generational Stability: Backed by essential public infrastructure, utilities, and state or local government tax autonomy, high-grade municipal bonds boast historical default rates well below 1% over multiple decades, according to Moody’s,² offering a safe harbor in a late-cycle economy.
• Unencumbered Asset Liquidity: Municipal securities provide clean, reliable liquidity and predictable revenues, entirely free from predatory fee structures, opaque valuations, or capital-access restrictions.

If you would like to learn more about the best way to capture the most compelling opportunities we are seeing, please let us know.

Municipal Bond Taxable Equivalent Yields Now Rival Those of Private Credit

• Clinton Investment Management’s Municipal Credit Opportunities yield-to-worst of 4.31% equates to roughly 9% when compared to corporate bonds or over 7.25% when compared to Treasuries, for those in the highest tax bracket living in a high tax state like New York.
• Contrasting with the private credit market, an asset class that has attracted sizeable capital inflows over the past several years, the relative value proposition shifts heavily toward municipals.
• We are of the firm belief that the structural fundamentals of municipal bonds provide a superior layer of investor protection compared to the opaque world of private corporate lending.
• The domestic economic engine experienced a pronounced slowdown, with advanced gross domestic product estimates revealing the U.S. economy decelerated sharply to a 1.5% annualized growth rate, a steep drop from the 2% expansion recorded in the first quarter of the year.
• The outlook for the municipal bond market remains exceedingly advantageous, in our view, as the convergence of slowing economic growth, a softening labor market, and a constrained central bank creates a constructive fundamental and technical backdrop for the asset class.

The second quarter of 2026 marked a pivotal transition period for global capital markets, characterized by a pronounced deceleration in domestic economic activity and an increasingly complex monetary policy landscape. For high-net-worth investors navigating this shifting macroeconomic terrain, the fixed-income markets offered divergent paths. On one hand, the broader corporate and private lending landscape began to exhibit symptoms of late-cycle fatigue, compressed spreads, and rising credit vulnerabilities. On the other hand, the municipal bond market emerged as an exceptionally resilient and fundamentally mispriced asset class. As tax burdens continue to erode nominal investment returns for individual investors in the highest tax brackets, the structural benefits of municipal securities have become glaringly apparent. Underneath the short-term market noise, macroeconomic data points to an economic cooling cycle that favors high-quality, fixed income assets. For capital allocators analyzing the relative value landscape, the tax-exempt arena currently presents an asymmetric risk-reward profile that outclasses highly leveraged corporate alternatives.

A rigorous evaluation of asset class fundamentals reveals that high-grade municipal bonds offer some of the most compelling taxable-equivalent yields observed in the post-pandemic era. For example, Clinton Investment Management’s Municipal Credit Opportunities yield-to-worst of 4.31%¹ equates to roughly 9% when compared to corporate bonds or over 7.25% when compared to Treasuries, for those in the highest tax bracket living in a high tax state like New York². Contrasting with the private credit market, an asset class that has attracted sizeable capital inflows over the past several years, the relative value proposition shifts heavily toward municipals. Private credit has traditionally positioned itself as a high-yielding alternative to traditional fixed income, yet its returns are fully taxable, severely diluting the net yield delivered to wealthy individuals. Furthermore, the private credit landscape is experiencing a rapid degradation in credit quality, with middle-market corporate borrowers facing intense margin compression from sustained elevated borrowing costs. The municipal market, however, offers investors exposure to sectors such as public infrastructure, utility systems, and state and local governments that possess tax autonomy, pricing power given essentiality of services they provide, together with historically stable, predictable revenue streams. In addition, municipal tax revenues are projected to increase, given widescale AI adoption at the enterprise level and resultant data center construction.

We are of the firm belief that the structural fundamentals of municipal bonds provide a superior layer of investor protection compared to the opaque world of private corporate lending. Historically, high-grade municipal securities have exhibited exceptionally low default rates, remaining well below one percent over multiple decades, according to Moodys’ Credit Default Study, 2024 data³. This sharply contrasts with the private credit market, where industry analysts are observing escalating corporate fragility and default rates climbing toward six percent among over-leveraged middle-market companies, according to Fitch⁴. This vast gulf in credit risk is exacerbated by the exorbitant fee structures embedded in private credit funds, which frequently charge two percent management fees alongside twenty percent performance hurdles for funds exposed to a meaningful degree of leverage. Heavy fee drag can result in a significant reduction of private credit investor returns over time, whereas active municipal asset management utilizes transparent, lower cost Separately Managed Account structures that maximize the pass-through of interest income to the underlying client. The liquidity dynamics of the two asset classes also illustrate the operational advantages inherent in the municipal bond market. Private credit vehicles routinely protect their illiquid underlying portfolios by implementing restrictive redemption terms, including the frequent deployment of multi-year capital lock-up periods and liquidity gates. During periods of economic stress, investors in these private funds often find themselves trapped, unable to reallocate capital as credit conditions deteriorate. Municipal bonds, conversely, typically trade within a deep, highly transparent institutional secondary market, allowing for continuous portfolio optimization, tax-loss harvesting, and a high level of liquidity without arbitrary holding penalties or withdrawal restrictions. This operational freedom ensures that wealth managers can dynamically adjust portfolio positioning as macroeconomic variables evolve. The structural contrast extends to the type of interest rate exposure embedded in these respective asset classes. Private credit is fundamentally built upon floating-rate debt instruments, a feature that benefited investors during the Federal Reserve’s aggressive tightening cycle but has now transformed into a distinct vulnerability. As the broader economy slows, corporate borrowers under floating-rate arrangements face immense debt-service pressure, and looming maturity walls, while investors are exposed to the risk of rapidly declining yields once monetary policy begins to ease. Municipal bonds are predominantly structured with fixed coupon rates, allowing informed investors to lock in high terminal yields for an extended period, should interest rates remain stable or decline over time, as is our expectation. By capturing these fixed rates at the cyclical peak of the interest rate cycle, municipal bond investors can further reduce their portfolio exposures to reinvestment risk which will inevitably plague floating-rate private credit strategies as benchmark yields move lower. It is important to remember that municipal bonds provide liquidity within one business day, in most circumstances, providing investors with the flexibility to adjust exposures as market conditions shift rather than when the investment manager deems the timing appropriate, as is currently the case for many investors currently gated in private credit vehicles.

The necessity of locking in these fixed yields is underscored by the macroeconomic data that defined the second quarter of 2026. The domestic economic engine experienced a pronounced slowdown, with advanced gross domestic product estimates revealing the U.S. economy decelerated sharply to a 1.5% annualized growth rate, a steep drop from the 2% expansion recorded in the first quarter of the year. This cooling economic trajectory was reinforced by a sudden and severe softening in the domestic labor market. The June 2026 non-farm payrolls report delivered a downward surprise to market participants, expanding by a mere 57,000 jobs and missing consensus expectations by more than half. This data illustrates that the labor sector, which had long served as the primary pillar of economic resilience, is no longer running hot and may be succumbing to the restrictive monetary environment.

While a volatile geopolitical energy landscape has kept headline inflation figures sticky and prevented an immediate, aggressive pivot toward monetary easing, this combination of anemic gross domestic product growth and a weakening employment backdrop is likely to pressure the Federal Reserve, Chairman Kevin Warsh and the Federal Open Market Committee. Recognizing the fragility of the economic expansion, the central bank opted to hold benchmark interest rates steady within the 3.50% – 3.75% range at its most recent meeting. The Federal Reserve is effectively handcuffed, constrained from pursuing further policy tightening by explicit signs of economic fatigue, yet hesitant to cut rates prematurely due to lingering, and potentially transient, localized price pressures. This prolonged pause by the monetary authorities establishes a highly favorable environment for fixed-income assets, as it removes the threat of further upward rate shocks while signaling that the next structural move in interest rates may be a cut as opposed to a hike.

Looking ahead, the outlook for the municipal bond market remains exceedingly advantageous, in our view, as the convergence of slowing economic growth, a softening labor market, and a constrained central bank creates a constructive fundamental and technical backdrop for the asset class. As cash yields on short-term instruments begin to lose their luster, we expect a meaningful rotation of capital out of money market funds and preferred savings vehicles back into long-term fixed-income securities, creating a powerful technical tailwind that will support valuations. Investors who proactively extend duration within municipal portfolios offering higher yields, stand to achieve not only elevated tax-free cash flow but may also enjoy significant capital appreciation alongside highly durable, tax-sheltered income streams. In an environment where corporate balance sheets may be pressured by rising input costs and the inability to pass on those higher costs to consumers already under financial strain, at the same time that private market vehicles are limiting redemptions, the clarity, safety, and attractive taxable-equivalent yields of the municipal bond market represent a haven for capital preservation and compelling tax-free cash flow. Active portfolio management and disciplined credit selection will remain paramount in separating premier underlying credits from localized areas of fiscal stress, enabling investors to fully capitalize on these unique macroeconomic conditions, against an uncertain economic and geopolitical backdrop.

What’s Happening?

• Municipal bond investors in the highest tax brackets have an opportunity today to lock in taxable equivalent yields approaching 9%*, compared to taxable corporate bonds. However, this opportunity may be fleeting. Once the Strait of Hormuz is reopened, energy prices are expected to drop, likely easing current inflationary pressures and causing interest rates to fall in the future.

• The municipal yield curve is roughly 100 basis points steeper than the current Treasury curve, indicating municipal investors are very well compensated to extend duration.

Where Should Municipal Investors Be Optimally Positioned?

• Short duration, passive strategies are likely to continue to underperform, as they have year-to-date and over the past three years, in our view.
• Given low absolute yields offered by short-to-intermediate municipal strategies, we believe investors should be underweight 2 to 8 year maturities.

Is Now a Good Time to Add to Municipal Bond Allocations?

• Year-to-date municipal new issue supply has been elevated, allowing CIM to expeditiously invest capital and construct new client portfolios effectively.
• The timing is ideal to add to municipal bond allocations, in our view, given stable underlying credit fundamentals, high taxable equivalent yields, and ample supply.
• We expect new issue municipal bond supply to moderate heading into the summer months, however, creating an attractive entry point today. Materially increased reinvestment dollars and continued strong fund flows are expected to result in fewer compelling relative value opportunities.
• Elevated interest rates present investors an opportunity to harvest losses across their municipal bond holdings, positioning portfolios to maximize tax-free cash flow and long-term total return. The tax alpha we may generate for clients complements the total return we have delivered over time.

Why CIM?

• CIM’s differentiated municipal bond strategies continue to deliver total returns that are among the highest in the municipal SMA industry for the 12-month period ending April 30, 2026, according to PSN Informa.

Unlocking Value: Trading Private Credit’s High Fees, Impaired Liquidity, and Declining Floating Rates for the Tax-Free Certainty and Security of Municipal Bonds

The municipal bond market navigated a turbulent first quarter in 2026, characterized by a “tale of two halves.” While the year began with robust demand and falling yields, a sharp reversal in March, driven by reignited inflation fears and the outbreak of the conflict in the Middle East, erased early gains. Despite this volatility, the fundamental case for municipal bonds has strengthened, particularly as a transparent and liquid alternative to the increasingly opaque private credit market.

Q1 2026 Market Performance and Yield Dynamics

The first two months of 2026 saw municipal bonds off to one of their strongest starts since 2020, with the Bloomberg Municipal Bond Index gaining over 2% through February. However, March brought a significant repricing due to geopolitical strife, with the 10-year tax-exempt benchmark yields, which had bottomed at 2.52% in late February, rising to end the quarter at 3.12% — a 59-basis point jump in a single month, according to the Municipal Market Data AAA muni curve.

Key drivers of the Q1 performance included¹:

• Technical Conditions: Record issuance in 2025 continued into Q1 2026, with total volume reaching $129.6 billion, up 7% year-over-year.
• Resilient Inflows: Despite March’s volatility, tax-exempt mutual funds and ETFs saw nearly $26 billion in net inflows for the quarter, comfortably absorbing supply, illustrating strong retail appetite.
• Yield Curve Shifts: The long end of the curve (30-year) became particularly attractive as the Muni/Treasury ratio rose to 91%, the highest level in nearly two years.

The Rising Tide of Local Taxes

In our recent Clinton Investment Jan Commentary, we highlighted a critical and growing risk: the increasing frequency of state and local tax increases across the country. We note that, while state-level credit fundamentals remain generally stable, local municipalities are increasingly choosing to raise income taxes on the wealthy to balance budgets as pandemic-era federal aid is fully exhausted and to address growing unfunded mandates.

We see this trend accelerating, evidenced by tax increase proposals in CA, VA, RI, and ME, together with passage of a 9.9% income tax increase in the state of Washington on those making more than $1 million, effective in 2028. Recently, the state of Illinois began considering a 3% “millionaire’s tax” on high earners.

Munis vs. Private Credit: The Safety and Yield Advantage

As the Federal Reserve continues to cut short-term rates, the landscape for income-seeking investors appears to be shifting away from floating rates, preferred savings, money market funds, and private credit, toward municipal bonds.

The Decline of Private Credit

Private credit, once the darling of the “yield at any cost” era, is facing significant headwinds in 2026.

• Fee and Liquidity Burdens: Private credit funds often charge high management and performance fees (e.g., 2% and 20%) and frequently utilize “lock-ups” and “gates” that prevent investors from freely accessing their capital during market stress, as is occurring with increasing frequency in the current environment, evidenced by the plethora of news articles referencing funds implementing these tactics.
• Floating Rate Risk: Most private credit loans are floating rate. As the Fed cuts rates, the yields on these loans will naturally decline, potentially eroding the income profile that attracted investors initially.
• Default Concerns: A recent quote from Fitch Ratings highlights the rising fragility in this sector, estimating a private credit default rate of roughly 6%.² By contrast, municipal bond default rates remain historically below 1%, according to Moody’s.³

The Taxable Equivalent Yield (TEY) Calculation

Municipal bonds currently offer a compelling alternative to private credit and other taxable fixed income instruments. with TEY’s of 8% to 9% for those in the highest tax bracket, seeking protection from federal, state, and local taxes.  For example, if a long-term muni bond offers a 5.00% tax-free yield (as seen recently in the 20-30 year area of the curve for NY), the TEY is approximately 8.45%.⁴

The visualization above illustrates how a base tax-free yield of 5.00% scales as the investor’s tax burden increases. In high-tax states like New York or California, the TEY can easily surpass 9.5% when accounting for both federal and state exemptions.

Conclusion

The first quarter of 2026 reaffirmed that while municipal bonds are not immune to interest rate volatility, they have historically been, and we believe will remain, among the most resilient and sound investments for high-income investors. When one considers the rising pressure to raise state and local taxes, especially on high-income earners, together with the rising default concerns, high fees, and declining floating rate yields in private credit, municipal bonds remain a compelling alternative given their return profile, credit stability and higher level of liquidity they offer investors.