Market Uncertainty in a Changing World
Periods of geopolitical stress tend to heighten volatility, capturing investors’ attention and testing their ability to remain patient and disciplined. In these environments, short-term sentiment can temporarily outweigh long-term economic fundamentals, which can increase volatility and unpredictability.
At Breckinridge, we believe that municipal bond investors’ fixed income allocations should add stability to their overall investment portfolios. We favor higher-quality bonds with a diversified maturity structure and steady duration exposure. A combination we believe is more likely to hold its value and potentially benefit from a flight to quality when risk assets come under pressure.
Why the Municipal Market Is Different
Beyond federally tax‑free interest income, municipal bonds can play a significant role in diversifying a portfolio away from stocks and other risk assets. Historically, investment‑grade municipal bonds have tended to move differently than equities, which can help smooth returns during periods of stock market volatility.
In a portfolio that includes both stocks and bonds, holding investments that do not all move in the same direction at the same time can help manage overall risk. Since 2000, investment‑grade municipal bonds have shown very low correlation with the S&P 5001, and during some equity market selloffs, they have even moved in the opposite direction. For investors seeking to reduce portfolio volatility and build a more balanced allocation over time, this potential diversification benefit makes municipals particularly compelling.
Understanding what is temporary and what endures in municipal markets
While market and interest-rate volatility can cause bond prices to fluctuate, fixed income investors should also recognize that higher rates can create opportunities to increase a portfolio's long-term income stream and total-return potential.
Over time, interest income, not capital appreciation or depreciation, can be the primary driver of a fixed income portfolio’s total long-term return. In a diversified portfolio of individual bonds, an investor may be able to reinvest maturities at higher market yields, building the income return portion of the portfolio return. Furthermore, this potential higher level of income can potentially help offset rate-induced price fluctuations.
What the broader economy tells us
Recent market sentiment has been heavily influenced by geopolitical developments. Beneath the headlines, however, economic data continues to point to a slowing yet resilient U.S. economy.
Labor market conditions remain mixed, with payroll growth exceeding expectations one month, but falling short in another, while consumer spending showed signs of moderation and business investment trends were mixed.
Our base case for 2026 is moderate real GDP growth, no change in the federal funds rate, and inflation that remains above the U.S. Federal Reserve's 2% target. Energy shocks could introduce upside risks to inflation, offset by expectations of slower growth. Overall, we expect longer term yields to remain rangebound.
Portfolio positioning in a challenging environment
Over the past five years, four developments have reshaped the municipal market:
- Yield levels have moved meaningfully higher and lower.
- Yield curve structures have changed.
- Credit differentiation has increased.
- Liquidity conditions have shifted.
Together, these market shifts have created opportunities for active municipal bond investors not only to build income and manage risk, but also to take advantage of tax‑loss harvesting2. In more volatile or higher rate environments, realizing losses can help offset taxes while allowing the portfolio to be repositioned into comparable bonds at lower prices and higher yields, potentially improving income over time and underscoring the value of active management in municipal separately managed accounts (SMAs).
More broadly, risk market volatility can impact high-quality municipal bond investors in the form of higher interest rates and/or wider credit spreads. The market and interest rate volatility in March 2026 improved after-tax yield opportunities. That said, ongoing geopolitical uncertainty and a more challenging municipal market backdrop call for an approach that stays alert to opportunities while remaining mindful of higher risks.
What portfolio managers are focusing on and what they are avoiding
Following the rise in yields during the March selloff, we see an opportunity to take advantage of higher absolute yields, better relative value versus Treasuries, and a steeper yield curve.
At the same time, the municipal market remains in the midst of a weak seasonal period highlighted by elevated new issuance and reduced re-investment demand. This may create a limited opportunity to act prior to the summer re-investment season where supply is typically more limited and demand increases.
Staying Grounded When Headlines Dominate
One reason investors choose to allocate to fixed income separate accounts and own high-quality municipal bonds directly, is that bonds can mature at par and provide a reliable return.
A portfolio of individual bonds can offer investors a haven from dysfunctional markets by generating a cash-flow return (coupons and principal) independent of the market. A more predictable and reliable return may help investors stay patient and avoid reacting to short-term volatility. Additionally, high-quality municipal investors also retain flexibility to hold through volatility, trade selectively when valuations improve, or realize tax losses when appropriate.
In any market environment, we believe high-quality, separate account municipal allocations should serve the purpose they were designed for: helping provide stability, dependable income, and capital preservation when investors need them most.