The opportunity in municipal bonds in 2026 (Podcast)

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Podcast transcript

Host/John Przygocki: Welcome to Talking Markets with Franklin Templeton. I'm your host John Przygocki from the Global Marketing Organization at Franklin Templeton. Today, I'm joined in the studio by Rick Polsinello, Senior Market Strategist with the Franklin Templeton Institute, and Ben Barber, Head of Municipal Bonds at Franklin Templeton Fixed Income.

The Institute is a research-centric group at the firm focused on delivering unique macroeconomic and capital markets insight to our clients. Franklin Templeton Fixed Income is one of the largest municipal bond portfolio managers in the United States and has been managing tax-free income strategies for over 40 years. Gentlemen, welcome to the show.

Rick Polsinello: Thanks, John.

John Przygocki: Thank you for joining me in the studio. I've really been looking forward to our conversation. Today, we are going to focus on the fixed income market, specifically municipal bonds in the United States.

Rick, can you ground us in the Institute's view on the state of the US economy?

Rick Polsinello: Thanks, John. Great to be here with you and also with Ben. And thanks to everyone who's taking time out of their day to listen to our thoughts here.

In terms of our view on the US economy, we’re very much of the opinion that it remains pretty resilient here. Our forecast for 2026 for real GDP (so, after the effects of inflation) is 2.5%, which is slightly above both what the Street consensus is right now and also the Fed's latest forecasts, which we got from their “dot plot,” or summary of economic projections, back in December. Those are both in the low twos [percent] but somewhat similar to ours. Again, ours is 2.5%.

The latest GDPNow figures that we've gotten from the Atlanta Fed, which come out essentially weekly at this point—they're still north of 4%. It's probably a little elevated. And it's definitely somewhat noisy. But, at least directionally, it does show you how the US economy is performing right now.

And the consumer has also been resilient. Capex [capital expenditure] spend has been good. On the fiscal side, it looks like tax refunds this year will come in at least 100 billion higher than they did in 2025. And the landscape in ’26, as we see it, is really constructive. Similar to ’25, but with some other tailwinds. We have Liberation Day behind us and kind of the fear of tariffs or the max fear of tariffs we think is also behind us. The passage of One Big Beautiful Bill. That certainly can be a little bit of a tailwind here. And then the fiscal impulse. But also on the monetary policy side, we could get another rate cut or two this year. And, assuming that we're correct that inflation isn't headed much higher from here and labor market doesn't tighten all that much, it could be a good situation.

We do look at it as getting low double-digit earnings growth on the equity side of things. We don't believe a recession is on the horizon in 2026. And much of the US dollar weakness that we've seen recently, we think is behind us for the most part.

As always, there could be challenges. Geopolitics. The concern there is certainly heightened right now. Any missteps by the Fed or even other major global central banks, that could create some volatility. But that's always the case. But overall, I would say we're very constructive on the backdrop for the US economy here in 2026.

John Przygocki: So, Rick, very constructive. Sounds like your group's view is that the economy is on solid footing, but we've got to keep an eye on things as the year starts to unfold. How does your group translate that macro view into some important themes that investors should be aware of here in 2026?

Rick Polsinello: Yeah, in talking with our hundreds of portfolio managers (there's over 600 portfolio managers here) and some of the other senior investment professionals across the firm, which we recently did, there were a handful of themes that became clear.

On the equity side of things, we seem poised here for a continued broadening of the market. And the others were related to fixed income. It's likely that our yield curve could steepen here in 2026. Also, innovation will continue to be a major investment theme this year. And then tax-aware investment strategies will also be in focus. So those are really the big four: steeper yield curve, a broader equity market, innovation continuing and also the tax management.

John Przygocki: All right. So, Rick, based on those four themes that you highlighted, let's focus in on the fixed income markets. Where do you see opportunity this year?

Rick Polsinello: Similar to 2025, in 2026 we think it's a constructive backdrop for fixed income generally, but with a few spots that seem poised to do a little bit better than others.

We always think of things in terms of crawl, walk and run in terms of the risk-return spectrum. And we believe the three spots that should have some nice tailwinds here are strategies on the front end of the yield curve, which would kind of be our crawl. On the opposite end of things of the risk spectrum would be high yield. That’s sort of our run. And our walk would be municipal bonds, which obviously we're talking about today, and where Ben will dig a little bit into our reasons and our investment thesis there. And these fit in nicely with most of our themes, namely: the steepening, the tax management and awareness and also innovation.

John Przygocki: All right, Ben, let me bring you into the conversation. Rick just mentioned municipal bonds. A couple quick questions for you right off the top. Do you agree with Rick's enthusiasm for the sector? And then, from your vantage point leading the muni bond business here at Franklin Templeton Fixed Income, can you share your outlook?

Ben Barber: Yeah, absolutely, John. Thanks. And Rick, good to be with you on this podcast as well. I think as we reflect back on 2025, there were a couple of things that took place in our markets that make our current situation pretty attractive. I think the main themes from 2025 would have been, you know, our curve steepened. And very interestingly, munis steepened more than Treasuries. We'll talk about that in a little bit. And that was, particularly apparent in the 20-to-30-year space where munis underperformed Treasuries, even at the AAA level of munis. So, there was muni underperformance. Credit spreads didn't really do too much in 2025 within the context of the muni market. So they were wider a little bit—wider about 10 basis points or so over the course of 2025.

And we think the combination of these couple of things really led to the opportunity set that we've got today. The credit fundamentals story in munis continues to be, at a minimum, stable. It's been very, very positive. As most people who have spent time speaking with the municipal bond team here at Franklin have known over the last couple of years, the credit fundamentals side of the equation has been really, really positive over the last four orfive5 years.

It still continues to be, at a minimum, stable across most of your traditional municipal sectors. There's some sectors that are under more challenge, of course, but overall credit fundamentals continue to be stable, if not slightly positive, across some of your traditional municipal sectors.

And so you wind all that up and you'd say munis underperformed Treasuries, number one. Number two, the curve steepened more than Treasuries over the course of 2025. Credit spreads didn't do a whole heck of a lot. And so you're left with, you know, the technical pressure in 2025 that was really the main cause of muni underperformance and the muni curve steepening a little bit more than the Treasury curve over the course of 2025. And it also led to credit spreads not really contracting in 2025—but, you know, quite the opposite, expanding a little bit in the face of a positive credit fundamental relationship.

So, all of that, to us, spells opportunity in today's market. And as you might conclude from a couple of those comments, we think the biggest opportunities right now in the muni market are probably out the curve and down the credit spectrum a little bit. That's where your highest relative values really are in the muni market.

So yeah, I do share Rick's enthusiasm for the muni market in here. I think there are plenty of opportunities where we're seeing the technical relationship over the last couple of months really, really improving in the municipal market. There's a lot of money coming in across all the main formats of muni investing: open-end funds, you know, ETFs, separately managed accounts [SMAs}.

And so, the technical relationship that was a little challenged in ’25 is certainly turning around here at the beginning of 2026. So, yeah, we like the market in here, John.

John Przygocki: All right. So, clearly an opportunity for us in 2026 in the muni bond space. We all know that we live in a world where (you mentioned it), relatively speaking, everybody is comparing one thing to another. With that thought, how should we think about the potential value of municipal bonds relative to other fixed income alternatives?

Ben Barber: It's a great question, and it is one that is absolutely front and center as part of all of the conversations we've been having with home offices, central research teams, you know, financial advisors out there in the marketplace. I'll give you a couple of interesting stats. When I talk to my colleagues in the rest of taxable fixed income, I continue to hear spreads are at or very, very close to all-time tights, historic tights across many of the other fixed income asset classes on the taxable side.

In tax-exempts, that's not the case. And in fact, you know, tax-exempts have really spread out quite nicely relative to other fixed income asset classes. One quick stat would be just the taxable equivalent yield right now of munis relative to the corporate index. And it's a pretty good comparison. The corporate index is actually slightly longer in duration. And it's certainly lower credit quality. Overall, the average credit quality of the corporate index is somewhere in that A-minus, maybe high BBB-type range. The average credit quality of the muni index is in the AA category. Durations are both in that sort of six-ish year option-adjusted duration. Again, the corporate index a little bit longer, closer to seven. And the muni index is a little bit closer to six. But they're in the same zone.

And when we think about the spread on a taxable-equivalent basis (so, again, taking into consideration taxes, what you would need to get in taxable fixed income to equate to your muni yield when considering taxes), the spread three years ago between those was about 40 basis points. Munis had a higher taxable-equivalent yield than the corporate index by about 40 basis points three years ago. Two years ago, that was about 80 basis points. In today's world, it's about 130 basis points. So, when you look at muni yields, this is really the crux of the matter. When you're thinking about the relative value of munis out there in the marketplace, it's all about what else you can do in fixed income. And right now, the difference in yields on a taxable-equivalent basis (so, getting to apples to apples) is really, really attractive for municipals.

That's one tool that we use when I'm thinking about muni relative valuation out there. You know, a lot of people will take a look at munis to Treasuries and look at that ratio over time. We talked about munis underperforming Treasuries through the course of 2025. And that was especially true out the curve. In the 10-year and shorter portion of the curve, it was about flat. Munis actually even outperformed in the very shortest portion of the curve. But in that 20-to-30-year part of the term structure, munis underperformed. Started 2025 at around 81% of, you know, muni yield divided by Treasury yield, and finishing right in that 86, 87%. So that's six ratios of cheapness out in that 30-year space muni to Treasury.

So, that's another tool that we'll use when thinking about muni valuations out there relative to Treasuries. But the taxable equivalent yield versus corporate index I think is a really telling feature of our market as well right now.

John Przygocki: All right. Thank you for that. Taxable-equivalent yield. Very important. I'm also getting the sense that the muni space is fairly complex. So, I think what I'd like to talk to you about now is the professional investment management and the importance of it. Maybe you could touch on that as well as some unique elements that your team brings to the municipal bond space.

Ben Barber: Well, you're hitting on a super important point in munis, and I like to talk about it as sort of the blessing and the curse of the municipal market. And that is, it's a retail-driven asset class. It tends to be very nuanced. It's less liquid. And so, all of those things make transacting in the municipal market difficult. And so, you know, that's the curse side of it. The blessing side of it is, it's a very opportunistic market and fantastic for us at Franklin Templeton Munis to be, you know, institutional investors in a retail-driven asset class.

When I think about my career in munis, that's one of the things that has been most advantageous. When thinking about a portfolio management group like ours, you know, to deal in the municipal market, we love the inefficiency of the municipal market. And I think it's uniquely inefficient due to the retail nature of the municipal market.

That combined with the fact that you've got a million different CUSIPs, you've got 50,000 different distinct issuers in the municipal market. So it's extremely, extremely fragmented. Information flow for the largest issuers, like New York City general obligation or the state of California, issuers like that, information flow is excellent. And you can get very up-to-date numbers, very easy to analyze, etc. As you go down the spectrum into the smaller issuers, maybe one-time issuers, or maybe issuers that just come to the market two or three times, as you might imagine, disclosure can get pretty few and far between. And so it can be very difficult to analyze the market. To your point, John, professional management, I would say on the trading side of things and just access to bonds, access to the market is a challenge. And it very much favors large institutional investors like us. And so that's just on the trading side.

On the research side, the institutional investors with large research groups like ours are definitely advantaged in this market in terms of research and getting disclosure when it's difficult, getting information. Obviously, the innovation that we've had with technology over the last several years has been incredible from that perspective, and we're definitely taking advantage of that. Jen Johnston, who heads up our research group, has been excellent at really driving the technological gains that we've had on the research and surveillance side of things. So that's been truly excellent. But, yeah, it definitely favors institutional investing. It definitely favors professional management in this market.

John Przygocki: So with that implied importance on professional investment management and the capabilities that you just spoke to, the other side of that equation is what I would characterize as access for investors. We hear these days about the different types of vehicles that provide access in different markets. In the muni space, is that an important component that your team focuses on as well?

Ben Barber: Yeah, absolutely. We're really, really proud of the fact that, in our group, we manage munis in all three of the main formats. Open-end funds: we have a huge array of open-end municipal bond mutual funds, which really appeal to a really, really wide audience. And they all differ in terms of state specificity or the amount of interest rate volatility, the amount of credit exposure we can have in the open-end mutual funds. And so that's really nice. The history of the Franklin Municipal Bond Department is we've been very, very large players in the open-end municipal bond mutual fund world for many, many decades. And so that's great.

In addition to that, we have really emphasized the ETF space over the last couple of years. And we're really proud to be able to say we're the largest number of state-specific funds in muni ETF space at this point. And so we are having a lot of success in attracting investors that are looking for that ETF format over the last couple of years. And so that's great that we offer the muni ETF space. And we'll continue to build that out without a question.

And the third major format, of course, is separately managed accounts. And that has been a very, very large and quickly growing portion of our business as well. The amount of customization that we can do in separately managed accounts today versus five years ago, 10 years ago, 20 years ago is amazing. And, again, technologically driven. We could not do this on a manual basis, but we can do a lot of customization with regard to separately managed accounts that is really, really helpful for a lot of investors.

So, we love the fact that we've got investor choice. And our idea is, it sort of benefits us in two ways. Number one, we want to be the one stop shop for any reasonable FA [financial advisor], any reasonable investor out there with regard to their municipal bond needs. And so, from a business perspective, of course, that's self-serving. We want to be big, and we want to be out there and offering this to clients.

On the portfolio management side, it's also a benefit because, in my view, we want to be involved in every aspect of the municipal market from super high grade, very, very short, all the way up to long-duration strategies that offer below investment grade. We want to be in all the formats of the open-end ETF, SMA. Because in our view, that gives us the best possible look into the market and the opportunities in the market, because all three of those formats will move at different times. And, so, to be involved heavily in all three is very, very helpful for our overall market views.

John Przygocki: Rick, let me turn to you. Ben just went through two really important aspects of the municipal business. Number one, the importance of professional investment management. And then number two, investor choice and what his team brings to the market. In your role as a senior investment strategist with the Institute here at Franklin Templeton, you're speaking with clients every day. So, I've got a few questions that I'd like you to think about here.

Number one, how often does the muni bond topic come up in those conversations? Number two, are your clients (financial professionals) seeing that opportunity? And third, are there any common themes or points that come up consistently as you're speaking with clients?

Rick Polsinello: In terms of how often the subject of municipal bond investing comes up, I would say pretty frequently, actually. In really almost every client conversation that we've had over the last few months, it seems to come up. This typically is the case towards the end of one year and the beginning of the next. And it also makes sense, just given all the attributes that Ben just spoke about. Also, all the money kind of on the sidelines, which is still about $7 trillion right now. And the general belief, I think by the markets that, you know, money market rates, CD rates, etc., they're going to be a bit lower by the end of this year, and folks are going to need to put some of that money to work. I think that's the first point.

The second, and Ben just touched upon this, is, if you look across the fixed income subsectors right now, spreads are extremely tight for taxable fixed income. Maybe not at all-time tights, but very close if not. And I think that this has helped a little bit put a spotlight on this really important fixed income subsector that, in my opinion, does seem to be a bit underloved from time to time.

In terms of, you know, investors, most don't do this themselves. As Ben said, they probably shouldn't. There's 50,000 issuers out there. I think there's a million CUSIPs right now. So, those are some of the reasons why I think it's come up a lot and probably will continue to be one of the big conversations that we have in 2026. And I think financial advisors and investment professionals in general see the opportunity here and probably a bit more than the end client.

It takes some education. Advisors need to explain to their clients that when they're looking at tax free munis, as Ben mentioned, it's really important to look at their taxable-equivalent yields. So, sometimes you have coupon yields that are in the high twos or low threes. But on a taxable-equivalent yield basis, that means that the yields that they would need to get in a taxable bond, that would be more like 5% or so in a lot of cases. You'd have to get 5% in taxable fixed income to kind of equal 2.5, 3% or so that you typically get within munis if you're going to make that fair apples-to-apples comparison between the tax-frees and the taxables.

John Przygocki: Ben, let me go to you. Any interesting insight there from Rick relative to his client conversations that you'd want to add to, reinforce, emphasize?

Ben Barber: I would like to emphasize the point Rick made regarding $7 trillion still floating around in the money market space. It's a staggering sum. And when you think about what is priced into the market right now from the perspective of Fed funds cuts over the course of 2026, we get two, two and a half cuts. Maybe it's 50, 75-ish basis points of cuts that are sort of priced into the market right now over the course of the next year.

And so, we know that $7 trillion is going to be in motion. And we have seen this over the last couple of years as people have extended out from money markets into duration fixed income. And that has been taking place. A lot of money has worked its way back into the muni market. But I think it's just the beginning.

And I think that's going to be a major, major theme over the course of 2026. And it's an easy call for FAs [financial advisors] to make to their clients to talk about their overall asset allocation, what (quote unquote) should they have in a normal asset allocation to cash and money markets and where are they now.

And what we continue to hear from the home offices out there when we're doing due diligence meetings with them, we continue to hear cash balances are way, way higher than what they view as a proper asset allocation. And so, with Fed fund cuts very likely over the course of the next year, nothing's guaranteed, of course, but it's pretty likely and it's pricing into the market. I think that movement from money markets out the curve is going to be really significant here in 2026. And I think munis, given where we are from a valuation perspective, I think it's a no-brainer call for FAs to make to their end user clients. So I would highlight that money market out the curve type of trade.

John Przygocki: Terrific. So, gentlemen, as we look to close for this morning's conversation, what I'd like to do is ask you each for a closing thought for our listeners. I'll turn to you, Rick, first.

Rick Polsinello: I think my closing thought would be that for active managers that have proven their investment skills (so, that would be, you know, like Ben Barber and his team), a great investment landscape is one where low valuations of an asset class have dislocated from the underlying fundamentals, which, again, we still think are solid in the municipal bond space. And it's usually due to technical factors and some headwinds. And this seems to be the case right now in the muni bond space. So, we think right now is an excellent time to allocate to this asset class before the markets as a whole come to the same conclusion—that spreads aren't as tight as they probably should be in the muni bond space—and prices start to go up.

It's a very high-quality investment option, has extremely low default rates, as Ben mentioned. They're essentially de minimis. And it's a great diversifier to equities in a total portfolio context. And, again, those robust taxable equivalent yields should be very attractive, particularly for individuals in the very high tax brackets.

John Przygocki: Ben, a final thought from you?

Ben Barber: I'm going to pick up right where Rick left off, which is thinking about asset allocation. I'll take it one step further and say, let's assume it's a given that that asset allocation is going to include some muni exposure for the vast majority of clients who are paying taxes here in the US. And so, let's assume munis is a given. Now, the next step down is trying to figure out for each client (whose asset allocation is very personal, obviously), what level of duration is the most appropriate? What level of credit risk is the most appropriate for your overall risk return asset allocation desires? And then, ultimately, what is the best format for you as an investor? Is it an open-end fund? Is it an ETF? Is it a separately managed account? So, I'm thrilled that we're here at Franklin Munis and we offer all this. And we can do any of the formats. We can do any of the different risk buckets from a duration and credit quality perspective.

So, I think that's really going to be the theme of 2026 for many, many investors out there is figuring out, “Okay, I'm underrepresented in munis. Let's get up to our proper asset allocation.” Now, the question, you know, to be discussed between FAs and clients will be, “What's the level of duration? What's the credit quality? And now let's go ahead and get started.”

John Przygocki: Thank you, Rick and Ben for your time here this morning and your wonderful insight in this conversation focused on the municipal bond market. To all of our listeners, thank you for spending your valuable time with us for today's update.

If you're interested in learning more, please visit franklintempleton.com. And if you'd like to hear more Talking Markets with Franklin Templeton, please visit our archive of previous episodes and subscribe on Apple Podcasts, Google Podcasts, Spotify or just about any other major podcast provider.