Municipal bonds may not get the same attention that other parts of the bond market do, but they can still play an important part of a bond portfolio. PIMCO's Head of Municipal Bond Portfolio Management, David Hammer, joined Yahoo Finance's Rachelle Akuffo to discuss renewed investor interest in municipal bonds amid improved bond markets.

Unlike treasuries and corporates, Hammer explains that longer-maturity muni bonds can offer higher yields than short-term alternatives. He describes how munis stand to benefit from the Federal Reserve's shifting stance towards rate cuts in 2024. Hammer says PIMCO sees a "stagnant economy" in 2024, which provides a "pretty good macro backdrop for muni bonds."

With banks like Citi (C) announcing it's closing its municipal bond business, Hammer highlights the trend of banks becoming "less present" in this market. As large institutions continue exiting, it opens an "opportunity for investors" to pursue relatively high, tax-advantaged muni yields.

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Video Transcript

RACHELLE AKUFFO: A lot of people are more familiar with corporate bonds and Treasury bonds. Talk about the space that muni bonds face here.

DAVID HAMMER: Yeah, well, muni bonds, the most common feature is that they are tax free to US investors in the top marginal tax bracket. And some key differences, you know, the shape of the curve. Longer-maturity munis today actually have higher yields than shorter-maturity munis, much different than the Treasury market or the corporate bond market. But just like corporate bonds, Treasury bonds, muni bonds do expect to benefit from a change in posture here by the Fed.

Inflation has peaked, the Fed told us as much yesterday, pricing in more cuts now in 2024. And the economy is beginning to slow. We see a stagnant economy here at PIMCO. That's a pretty good macro backdrop for muni bonds in terms of both earning higher tax-free yields, but also the chance to benefit from capital appreciation.

RACHELLE AKUFFO: So then the move by Citigroup, the bank has said that they've not really seen the overall returns that they would have liked in the muni business, is that something then that you expect to continue into 2024?

DAVID HAMMER: Well, you know, of the reasons that the muni curve is steeper, that longer maturities offer higher yields, is that banks have been less present. Their tax rates are lower today than they were before tax reform in 2017, moving from a 35% tax bracket down to a 21% tax bracket. So we do think banks are likely to be less present in the muni market. We see this as an opportunity for investors to really step into the void that they're creating here and buying bonds with higher yields than what we would have typically seen when banks were a bit more active.

RACHELLE AKUFFO: And I want to ask you about the domino effect because at the local level, at least, we see those sorts of bonds backed by property taxes. So when you look at what we're seeing currently with property taxes, what is that telling us about what to expect in the coming year?

DAVID HAMMER: Yeah, it's a pretty positive indicator for local muni credit quality. Most local muni bonds, they're backed by property taxes. And the repayment mechanism it's based on, what are houses worth versus the assessed values. And what's fairly typical in the muni market, assessed values lag and that's happened over the last couple of years here.

Home price appreciation is up 10%, 15%, 20% in some local areas. Muni bonds that are backed by property taxes, the assessed value, so where are they on the tax roll, those are just beginning to catch up. It takes time as property values are reassessed or homeowners sell to new homeowners that pay a higher property tax. And that's really good for local credit quality. We expect to continue the improvement over the next few years.